The National Pension Scheme (NPS) is one of the most popular and government-approved retirement savings options in India.
With its flexible structure and tax benefits, NPS provides an excellent way for citizens to plan their retirement and secure a regular income.
However, when it comes to NPS, many people are unaware of the difference between Tier 1 and Tier 2 accounts.
| Feature | Tier 1 | Tier 2 |
|---|---|---|
| Purpose | Long-term retirement savings plan | Flexible savings plan |
| Eligibility | Open to Indian citizens aged 18–70 years | Requires an active Tier 1 account |
| Lock-in Period | Locked until the subscriber turns 60 years | No lock-in period; funds can be withdrawn anytime |
| Minimum Contribution | ₹1,000 per financial year | ₹250 per financial year |
| Tax Benefits | Up to ₹1.5 lakh deduction under Section 80CCD(1) + ₹50,000 under Section 80CCD(1B) | No tax benefits |
| Withdrawal Rules | Restricted: Partial withdrawal allowed after 3 years (25%) | Unrestricted withdrawals anytime |
| Maturity | At age 60: 60% corpus as lump sum; 40% must be used for annuity purchase | Not applicable |
| Investment Choice | Active or auto-choice | Active choice only |
| Account Maintenance Charges | Applicable | Not applicable |
Introduction to Tier 1 Account
The NPS Tier 1 account is the mandatory account for all NPS subscribers. It is designed to be the primary retirement savings account and comes with specific rules for tax benefits and withdrawals.
Once you open a Tier 1 account, it’s locked in until the age of 60, ensuring that you accumulate savings for your post-retirement life.
Key Features of Tier 1 Account
- Lock-in Period: The Tier 1 account has a lock-in period until the age of 60, ensuring that the funds are used exclusively for retirement.
- Tax Benefits: Contributions made to the Tier 1 account are eligible for tax deductions under Section 80CCD(1) and 80CCD(1B) of the Income Tax Act. The deductions allow you to reduce your taxable income by up to ₹1.5 lakh annually.
- Partial Withdrawal Rules: While the Tier 1 account is locked in, you are allowed to make partial withdrawals under specific circumstances, such as for medical emergencies, children’s education, or home purchase.
- Mandatory Contributions: Contributions to the Tier 1 account are mandatory for government employees, while private-sector employees and self-employed individuals can also participate voluntarily.
Tax Savings with Tier 1 Account
The Tier 1 account provides significant tax advantages. Under Section 80CCD(1), you can claim a deduction of up to ₹1.5 lakh per year on contributions.
Additionally, you can claim a further deduction of up to ₹50,000 under Section 80CCD(1B) for contributions made to Tier 1, which is over and above the ₹1.5 lakh limit.
This makes NPS Tier 1 one of the most attractive tax-saving tools available today.
What is an NPS Tier 2 Account?
Introduction to Tier 2 Account
The NPS Tier 2 account is a voluntary account that offers more flexibility than Tier 1.
While Tier 2 accounts can only be opened after opening a Tier 1 account, they provide an excellent way to save and invest for short-term goals or for liquid investments.
There’s no lock-in period for Tier 2, so you can withdraw your funds at any time, making it an attractive option for those who want greater liquidity.
Key Features of Tier 2 Account
- No Lock-in Period: Unlike Tier 1, the Tier 2 account does not have any mandatory lock-in. You can withdraw funds from your Tier 2 account at any time.
- Tax Benefits: Tier 2 accounts do offer limited tax benefits, but only for government employees. Contributions to Tier 2 accounts by government employees are eligible for tax deductions under Section 80C of the Income Tax Act. However, private-sector employees do not get any tax benefits from contributing to Tier 2.
- Flexible Withdrawals: The Tier 2 account allows for flexible withdrawals, unlike the Tier 1 account, which is meant exclusively for retirement savings.
- Investment Options: You can invest in a range of asset classes in Tier 2 accounts, including equities, government bonds, and corporate debt.
Taxation in Tier 2 Account
While government employees can enjoy the benefit of tax deductions under Section 80C for contributions to Tier 2, private-sector employees do not receive any tax relief.
This means that the tax advantage of Tier 2 accounts is limited compared to Tier 1.
Tier 1 vs Tier 2 in NPS: Key Differences
To help you understand the differences better, here’s a simple comparison between Tier 1 and Tier 2 accounts:
| Feature | Tier 1 Account | Tier 2 Account |
| Lock-in Period | Yes (until 60 years of age) | No lock-in period |
| Tax Benefits | Yes (Section 80CCD(1), 80CCD(1B)) | Limited (only for government employees) |
| Eligibility | Mandatory for all NPS subscribers | Voluntary, after Tier 1 account |
| Withdrawal Rules | Restricted (only partial withdrawal allowed) | Flexible, withdrawals allowed anytime |
| Contributions | Mandatory for government employees | Voluntary, but only after Tier 1 account |
| Purpose | Retirement savings | Investment and savings flexibility |
Which Account Should You Choose?
When deciding whether to open Tier 1 or Tier 2, it depends on your goals:
- Tier 1 Account: Ideal for long-term retirement planning. If you’re looking to save for your post-retirement life and benefit from tax deductions, Tier 1 is the right option for you.
- Tier 2 Account: If you need flexibility and liquidity, and don’t mind the limited tax benefits, Tier 2 is a great option for short-term savings and investments.
Benefits of Having Both Tier 1 and Tier 2 Accounts
While each of these accounts has its own unique benefits, many people choose to open both Tier 1 and Tier 2 accounts to combine the tax savings of Tier 1 with the liquidity and flexibility of Tier 2.
- Tier 1 for Retirement Savings: Focus on long-term, tax-advantaged savings for your retirement.
- Tier 2 for Short-Term Flexibility: Use Tier 2 to save for medium-term financial goals while enjoying the flexibility of easy withdrawals.
How to Open Tier 1 and Tier 2 NPS Accounts
Opening an NPS account, whether Tier 1 or Tier 2, is simple and can be done online.
- Visit the official NPS website: Go to the NSDL eNPS Portal.
- Select the type of account: You will be prompted to choose between Tier 1 and Tier 2 accounts.
- Fill out the application form: Provide your personal details, bank account information, and KYC documents.
- Submit and verify: Complete the verification process through OTP, Aadhar authentication, or by visiting a Point of Presence (PoP).
- Make an initial contribution: The minimum contribution for opening a Tier 1 account is ₹500, and for Tier 2, it is ₹1,000.
Frequently Asked Questions (FAQs) About Tier 1 and Tier 2 in NPS
1. Can I open only a Tier 2 NPS account?
No, you must open a Tier 1 account first before you can open a Tier 2 account.
2. What happens if I withdraw from my Tier 1 account before age 60?
You can only make partial withdrawals from the Tier 1 account under specific conditions like medical emergencies or children’s education. Full withdrawal is allowed only after 60 years of age.
3. Is Tier 2 better than mutual funds?
While Tier 2 provides flexibility in withdrawals, it may not offer the same returns as some mutual funds. The Tier 2 account is primarily for NPS subscribers who seek tax advantages under Section 80C.
4. How is the tax on Tier 2 withdrawals treated?
There is no tax on Tier 2 withdrawals for private-sector employees. For government employees, tax is applicable only if the funds are used for a non-retirement purpose.
Conclusion
Both Tier 1 and Tier 2 accounts in the National Pension Scheme (NPS) offer unique benefits suited to different financial goals.
While Tier 1 is designed primarily for long-term retirement savings, Tier 2 offers greater flexibility for short-term investments.
By understanding the features, tax benefits, and withdrawal rules of each, you can decide which account—or combination of accounts—best suits your financial needs.