NPS Tier 1 & Tier 2: Definition, Contributions, Returns, and More

National Pension System (NPS), being a government-sponsored retirement savings scheme, is designed to help individuals build a financial cushion for their golden years. It offers a structured approach to long-term savings, with contributions made during the working years accumulating to provide a steady income post-retirement.

What sets this retirement scheme apart is its two-tiered structure – Tier 1 and Tier 2 – each with its unique features and benefits. Understanding the nuances of these tiers is essential for individuals looking to chart a course towards financial stability in their golden years.

In this complete guide, we will cover NPS Tier 1 & Tier 2, their definitions, contributions, and more. Whether you're a seasoned investor or a newcomer planning for retirement, knowing about NPS Tier 1 and 2 in detail can help you make informed decisions.

What is Tier 1 and Tier 2 in NPS?

These are two types of NPS accounts, each serving distinct purposes within the NPS framework. Despite sharing similarities in structure and fund schemes, a Tier 1 account is needed to open a Tier 2 account. You should also know that:

• Tier 1 NPS account is primarily tailored for retirement savings. You can open this account with a minimum contribution of ₹500. The scheme allows for withdrawal of up to 60% of the total accumulated amount post-retirement. You need to use the remaining 40% to purchase annuities to get a steady monthly income in the form of a pension.
• In contrast, NPS Tier 2 is an open-access account with a minimum investment threshold of ₹1000. Whenever you opt for withdrawals from this account, it will typically take around three days to transfer funds from the trustee's bank account to your bank account. 
• Unlike Tier 1, Tier 2 allows subscribers to withdraw the entire corpus as a lump sum or opt for multiple withdrawals without any limit.

While Tier 1 and Tier 2 NPS accounts share some functionality, their differences are apparent, catering to diverse financial needs and goals. Before these fundamentals, let’s get into the finer differences between NPS Tier 1 &. Tier 2.

NPS Tier 1 vs. Tier 2: Detailed Comparison

The distinction between Tier 1 and Tier 2 NPS accounts lies in their operational characteristics and associated benefits. Here's a detailed comparison to help you understand which investment account suits your financial objectives better.

1. Mandatory contributions

Tier 1 necessitates at least one annual contribution, whereas Tier 2 does not impose such obligations and offers flexibility in payment schedules. Consequently, Tier 2 allows account holders to skip contributions in lean financial periods and use the contributed funds anytime, as in the case of a savings account.

2. Eligibility

Tier 1 is accessible to any Indian citizen aged between 18 and 65, granting them a Permanent Retirement Account Number (PRAN) upon application. Conversely, eligibility for Tier 2 mandates subscribers to open an NPS Tier 1 account first.

3. Lock-in period

While NPS Tier 1 funds remain locked until you reach 60 years of age, Tier 2 imposes no such restriction, enabling withdrawals at any time.

4. Tax benefits on contribution

NPS Tier 1 contributions are eligible for tax deductions of up to ₹1.5 lakhs under Section 80CCD (1) and an additional ₹50,000 under Section 80CCD (1B). In contrast, Tier 2 does not provide tax benefits on contributions (detailed below).

5. Taxation on withdrawal

Upon maturity, NPS Tier 1 withdrawals are tax-exempt, whereas Tier 2 withdrawals will be added to your overall income and are subject to taxation at your applicable income tax slab rate.

Despite these disparities, both NPS Tier 1 and Tier 2 share similarities, including uniform fund management charges and access to various asset classes such as equity, corporate debt, government securities, and alternative investment funds. 

Eligibility Criteria to Open NPS Tier 1 Account

Here's a breakdown of who qualifies to open NPS Tier 1 account:

• Indian Citizenship

NPS Tier 1 accounts are open to Indian citizens, regardless of residency status. This includes residents, non-residents, and Non-Resident Indians (NRIs).

• Age requirement

The minimum age to open an NPS Tier 1 account is 18 years, ensuring accessibility to young individuals keen on initiating their retirement planning journey. As of August 2021, the maximum age limit for opening an account stands at 70 years. However, subscribers have the option to defer account activation until the age of 75.

Steps to Open NPS Tier 1 Account Online

1. Visit the official e-NPS portal and register as a user.
2. Enter the required information and await the OTP sent to your registered mobile number
3. Verify the OTP to successfully log in to your account.
4. Select the option for opening a Tier 1 account. 
5. Choose from a selection of eight fund managers to oversee your investments.
6. Decide your preferred asset allocation strategy by selecting either the ‘active’ or ‘auto’ mode.
7. Complete the nomination process by specifying the share of your accumulated savings for each nominee, ensuring clarity in the event of unforeseen circumstances.
8. Alongside the registration form, upload the necessary Know Your Customer (KYC) documents to verify your identity and address.
9. Make an initial contribution of a minimum of Rs. 500 to finalize the registration process and activate your NPS Tier 1 account.

Documents Required to Open NPS Tier 1 Account

• Proof of your identity
• Proof of your address
• Proof of your date of birth
• Duly filled registration form

Withdrawal Rules Related to NPS Tier 1 Account

In conclusion, the power to shape a brighter tomorrow lies in informed decision-making and proactive planning. NPS scheme is a hope for millions of Indians seeking a secure future. By carefully selecting NPS Tier 1 & Tier 2 accounts, you can build a robust retirement savings strategy.

FAQs

1. Which is better - NPS Tier 1 or Tier 2?

Answer: The suitability of NPS Tier 1 or Tier 2 depends on your financial goals and preferences. Tier 1 is tailored for retirement savings with tax benefits but has restrictions on withdrawals. On the other hand, Tier 2 offers more flexibility for withdrawals but lacks tax benefits associated with retirement savings. Choosing between them requires considering long-term financial planning, liquidity needs, and tax implications.

2. Is NPS Tier 1 tax free?

Answer: Contributions to NPS Tier 1 are eligible for tax benefits under Section 80CCD(1) of the Income Tax Act, subject to specified limits. However, withdrawals from Tier 1 are taxed as per the prevailing tax laws. While investments in Tier 1 enjoy tax benefits, the taxation aspect upon withdrawal depends on the chosen annuity option and your tax bracket. 

3. Is NPS Tier 2 good or bad?

Answer: The assessment of NPS Tier 2 as good or bad depends on your financial objectives and preferences. Tier 2 offers flexibility in withdrawals without the constraints of a lock-in period, making it suitable for short to medium-term savings goals or emergency funds. However, it does not provide tax benefits for contributions. Therefore, you should evaluate their liquidity needs, investment horizon, and tax implications to determine whether NPS Tier 2 aligns with your financial plans.

4. Should I opt for NPS tier 1?

Answer: Tier 1 offers tax benefits on contributions under Section 80CCD(1) of the Income Tax Act, making it advantageous for retirement savings. However, you should know that withdrawals from Tier 1 are restricted until retirement age and are subject to taxation. If you prioritize long-term retirement savings with tax benefits and are comfortable with the lock-in period, NPS Tier 1 could be a suitable option. 

6. Is it mandatory to invest in NPS Tier 2?

Answer: No, investing in NPS Tier 2 is not mandatory. It is optional and you can open it if you already have a Tier 1 account.