Difference Between Tier 1 and Tier 2 in NPS

6 mins read

by Angel One

NPS Tier 1 and Tier 2 accounts are two types of accounts that are available under the retirement savings scheme. Understanding the differences between these two accounts is crucial for making well-informed investment decisions.

The National Pension System (NPS) is one of the most attractive retirement-focused savings schemes in India. It allows you to create a steady source of passive income that can help you meet your post-retirement expenses and provides market-linked returns.

If you plan to financially secure your life after retirement, investing in the National Pension System can help you achieve your goal. However, you must first understand the scheme and its various intricacies to make informed investment decisions.

One of the key aspects of the scheme that often confuses investors is the distinction between NPS Tier 1 and Tier 2 accounts. In this article, we will explore these two accounts, ascertain their differences, and help you choose the right account for your needs.

NPS: An Overview

Before we delve into a comparison of NPS Tier 1 vs. Tier 2 accounts, let us quickly look at the scheme in general.

The National Pension System (NPS) is a voluntary contribution pension system. Subscribers contribute funds to an NPS account, which is then used to invest in a pension fund managed by experienced professionals.

Once the subscribers attain 60 years of age, they can withdraw a maximum of up to 60% of the accumulated corpus in their NPS accounts as a lump sum. The funds remaining after the lump sum withdrawals are then used to purchase an annuity plan that offers income at regular intervals in the form of a pension.

The primary goal of this retirement scheme is to encourage people to save for their retirement systematically. One of the highlights of the National Pension System is that it offers subscribers the flexibility to choose their investment options based on their risk appetite and age.

What is Tier 1 and Tier 2 in NPS?

In NPS, Tier 1 and Tier 2 represent two different types of accounts that subscribers to the scheme can open. Here is a closer look at these two accounts.

Tier 1 NPS Account

The Tier 1 account is the primary NPS account and forms the core of the pension scheme. Subscribers to the scheme must mandatorily open a Tier 1 account. This account has certain withdrawal restrictions and is more suited for long-term goals.

Tier 2 NPS Account

The Tier 2 account is an optional NPS account that subscribers to the scheme can open in addition to a Tier 1 account. This account is more flexible and does not have any withdrawal restrictions, making it more suitable for medium-term and short-term goals.

Also Read More About NPS Tax Benefits

Difference Between Tier 1 and Tier 2 NPS Accounts

Here is a detailed tabulated comparison of NPS Tier 1 vs. Tier 2 accounts to help you understand the various distinctions between these two types of accounts.

Particulars	NPS Tier 1 Account	NPS Tier 2 Account
Requirement	Every NPS subscriber must mandatorily open a Tier 1 account.	Opening a Tier 2 account is optional.
Eligibility	All Indian citizens, including residents and non-residents between the ages of 18 and 70 can open an NPS Tier 1 account.	Only individuals with an active Tier 1 NPS accounts are permitted to open a Tier 2 account.
Minimum Initial Investment	At the time of account opening, subscribers must make a minimum initial investment of at least ₹500.	At the time of account opening, subscribers must make a minimum initial investment of at least ₹1,000.
Minimum Amount Per Contribution	Tier 1 account holders must make a minimum amount of ₹500 per contribution. Additionally, there is also a minimum contribution limit of ₹1,000 per financial year.	Tier 2 account holders must make a minimum amount of ₹250 per contribution.
Lock-in Period	The funds invested in Tier 1 NPS accounts are locked in until the subscribers attain 60 years of age.	Tier 2 NPS accounts do not have any kind of lock-in periods.
Withdrawal Facility	Fund withdrawals from Tier 1 NPS accounts are restricted until the subscriber attains 60 years of age, at which point up to 60% of the total accumulated corpus can be withdrawn as a lump sum.	Tier 2 NPS accounts do not have any fund withdrawal restrictions. Subscribers can freely withdraw funds from the accounts as and when they wish.
Tax Benefits	Subscribers can claim the contributions they make to Tier 1 NPS accounts as a deduction under section 80C of the Income Tax Act up to a limit of ₹1.5 lakh per financial year. In addition to this, they can claim another deduction of up to ₹50,000 per financial year under section 80CCD(1B) of the Income Tax Act.	Contributions made to Tier 2 NPS accounts are not eligible for any kind of tax deductions or benefits. Government employees, however, can deduct Tier 2 NPS contributions up to ₹1.5 lakh per financial year under section 80C of the Income Tax Act.

NPS Tier 1 vs. Tier 2: Which is Better?

As you have already seen, an NPS Tier 1 account is mandatory, meaning that every subscriber who opts for this retirement scheme must open the account. So, the question is whether you should open a Tier 2 account in addition to a Tier 1 account. Here is a quick guide to help you decide.

If you are an individual with long-term retirement savings as your primary goal and wish to take advantage of tax benefits, you can stick to just opening a Tier 1 account. However, it is important to keep in mind that you will have limited access to your funds until you attain 60 years of age.

Know More About NPS Withdrawal Rules

However, if you wish to infuse a little flexibility in terms of fund withdrawals and are looking for a low-cost investment avenue for short- to medium-term goals, you can consider opening both NPS Tier 1 and Tier 2 accounts. Opening both accounts will allow you to balance long-term retirement savings with flexible short-term investments.

Conclusion

With this, you must now be aware of the difference between Tier 1 and Tier 2 NPS accounts. Both of these accounts offer distinct features catering to different financial needs. Tier 1 accounts provide tax benefits and enforce disciplined long-term savings. Tier 2 accounts, on the other hand, offer flexibility and liquidity, making them suitable for medium-term financial goals.

While Tier 1 is a mandatory account and forms the core of your NPS portfolio, the addition of a Tier 2 account is optional and can provide a balanced approach to managing your finances. However, the decision to open an additional Tier 2 account must be taken only after carefully considering factors such as your overall financial strategy, retirement goals, tax planning, liquidity needs, and risk tolerance.

FAQs

Can I open a Tier 2 account without having a Tier 1 account?

No. Opening a Tier 2 account in the National Pension System will only be permitted if you have an active Tier 1 account.

Are there any tax benefits for contributions to Tier 2 accounts?

No. Contributions to NPS Tier 2 accounts are not eligible for any tax benefits whatsoever. All of the tax benefits are reserved only for Tier 1 accounts.

What are the maximum contribution limits applicable to Tier 1 to Tier 2 accounts?

There are no maximum contribution limits for NPS Tier 1 and Tier 2 accounts. However, the maximum amount of contribution you can claim as a deduction under section 80C of the Income Tax Act of 1961 is limited to ₹1.5 lakh per financial year. Furthermore, this income tax deduction is only applicable for contributions to Tier 1 accounts.