NPS Tier-1 vs NPS Tier-2

What is NPS?

NPS stands for the National Pension System. It is a scheme launched by the Government of India to provide citizens with a systematic architecture for regular savings & investments to meet their post-retirement financial needs. This is available for the general public between the age of 18-65 years. Regular contributions are made in the scheme by the employee, individuals, or employer to create a corpus amount for the individual’s retirement. The amount contributed in this scheme is further invested in different asset classes as per the investment option selected by the employee/individual.

The different asset classes available for investment allocation in the NPS scheme are as follows:

Class A: Invest in Alternative Investments

Class C: Invest in Corporate Bonds

Class E: Invest in Equity Securities

Class G: Invest in Government Bonds

Types of NPS account

There are two types of NPS account offered under the scheme which are:

NPS Tier-1: The NPS Tier-1 account is a retirement saving account which has a lock-in period till the retirement age of the account holder. This account doesn’t allow withdrawals before maturity. The main objective of this account is to create a large corpus by making regular contributions & investments into different asset classes as per the chosen option of the subscriber. At retirement, a portion of the corpus needs to be used to buy an annuity scheme offering regular pension and the rest could be withdrawn as a lump sum by the account holder. In a tier-1 account, it is mandatory to do at least 1 contribution in every financial year.
NPS Tier-2: NPS Tier-2 account is a voluntary account that can only be opened by the NPS tier-1 account holders. Unlike the Tier-1 account, the tier-2 account doesn’t have a lock-in period and therefore, allows the account holders to make withdrawals from the account at any time as per their requirements. Also, there are no restrictions with respect to the maximum amount or frequency of withdrawals.

Difference between NPS Tier-1 and NPS Tier-2 account

There are many differences between the NPS Tier-1 and Tier-2 accounts. Some of the major differences between both accounts are:

1. Eligibility

The tier-1 account can be opened by any Indian citizen or NRI between the age of 18 years - 65 years while the Tier-2 account can only be opened by the Tier-1 account holders.

2. Lock-in period

The tier-1 account has a lock-in period till the retirement of the account holder while the tier-2 account doesn’t have any lock-in period. The Tier-2 account offers high flexibility to subscribers by allowing withdrawals at any time.

3. Partial Withdrawals

The tier-1 account gives the facility to partially withdraw up to 25% of the corpus after the completion of 3 years from the date of opening the account. The withdrawals are allowed for a maximum of 3 times during the period till retirement. Also, there is a requirement of a mandatory gap of 5 years between these withdrawals except in the case of withdrawals for meeting medical emergencies.

While the Tier-2 account corpus can be withdrawn anytime. It gives the flexibility to its account holder to anytime withdraw the corpus amount as per the needs.

4. Contribution

The minimum amount which needs to be deposited at the time of the account opening in the Tier-1 account is Rs.500 while in the case of the Tier-2 account, it is Rs.1,000.

The minimum subsequent contribution amount in the Tier-1 account is Rs.500 while in the Tier-2 account is Rs.250. And there is no maximum limit for contributions into both accounts.

The minimum balance required to be maintained at the end of each financial year in the NPS Tier-1 account is Rs.1,000. And there is no requirement for the maintenance of minimum balance in the case of a Tier-2 account.

5. Frequency of contributions

In the Tier-1 account, it is mandatory to do at least 1 contribution per financial year while it is not mandatory to do any contribution in the Tier-2 account.

6. Tax benefits under 80C

The Tier-1 account offers the benefit of tax deductions. The contributions done in the Tier-1 account are eligible for claiming deductions of up to Rs.1.5 lakh per financial year under section 80C of the Income Tax Act, 1961.

Whereas, the Tier-2 account doesn’t give any tax deductions to the general public except for the government employees. The government employees can claim deductions under 80C for their contributions into the NPS Tier-2 account. That account will have a lock-in period of 3 years.

7. Taxation on gains

Income earned on the Tier-1 account is tax-free i.e the subscriber doesn’t need to pay any taxes on the gains earned on their NPS investment.

While the returns on the Tier-2 account is added into the income of the account holder and is taxed as per the tax slab rate of the individual.

NPS Tier-1 vs NPS Tier-2

	NPS Tier-1	NPS Tier-2
Eligibility	Any Indian citizen between the age of 18 - 65 years.	Tier-1 account holders
Lock-in period	Till the retirement	No lock-in period
Premature withdrawals	Allowed up to 25% of the corpus. Max. 3 times during tenure.	Can be withdrawn anytime as per the needs and requirements.
Withdrawals at maturity	Allowed up to 60% of the corpus as lumpsum and at least 40% needs to be used for the annuity.	No maturity. Withdrawals allowed anytime as per requirements.
Deposit while opening account	Minimum- Rs.500	Maximum- Rs.1,000
Frequency of deposits	At least 1 every financial year	Not mandatory
Minimum contributions	Rs.500	Rs.250
Management Costs	0.01%	0.01%
Tax benefits	Tax deductions on the contribution amount of up to Rs.1.5 lakh per financial year under section 80C of the Income Tax Act, 1961	Doesn’t give any tax benefits except for government employees. In that case, there will be a lock-in of 3 years.
Taxation on Gains	Income earned is tax-free	Income earned is added to the income and is taxed as per the income tax slab rate of the individual.

Frequently Asked Questions

What is the NPS account?

The National Pension Scheme or NPS account is a retirement saving scheme sponsored by the Government of India. It helps the subscribers to systematically make regular contributions into the account and create a large corpus to meet the financial needs after their retirement.

How many types of accounts are offered under the NPS scheme?

There are two types of account offered under the scheme which are:

NPS Tier-1 which is the retirement account
NPS Tier-2 which is a voluntary account. This account can be opened only when the subscriber has an active NPS account.

What are the tax benefits of NPS account?

Contributions made into the NPS Tier-1 account are eligible for tax deductions. It gives the deductions of up to Rs. 1.5 lakh per financial year under Section 80C of the Income Tax Act, 1961.

However, the NPS Tier-2 account doesn’t offer any tax benefits except to the government employees. Only those employees are eligible to claim deductions under Section 80C. In that case, it will have a lock-in period of 3 years.

Do the income earned on the NPS account is tax-free?

Income or gains earned on the Tier-1 account is tax-free while the interest earned from the Tier-2 account is taxable. It is taxable as per the income tax slab of the account holder.

Does NPS have a lock-in period?

NPS Tier-1 account has a lock-in period till the retirement age while the NPS Tier-2 account does not have a lock-in period and the corpus can be withdrawn anytime.

Is partial withdrawal allowed in NPS Tier-2 account?

The withdrawals from the NPS Tier-2 account can be done anytime as per the investor’s requirements. It does not have a lock-in period while the withdrawals from the NPS Tier-1 account are allowed only up to the 25% of the corpus for a maximum of 3 times during the tenure.

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