The National Pension System (NPS) is the strongest ray of hope when it comes to the right way to invest for your retirement. Recently, we thoroughly explained the concept of NPS and how will it benefit you with retirement.
Now, the folks have been asking us which is better NPS 1 or 2, and how NPS 2 is different from NPS 1…
So, in this write-up, we are going to deep dive into the NPS Tier 2 benefits & its key differences with NPS Tier 1.
Stay tuned!
(A) What is NPS Tier 2?
If you’ve already set up a Tier 1 Account with the National Pension System (NPS), you have the option to open a Tier 2 NPS account. This secondary account grants you the flexibility to withdraw or invest funds as you see fit.
With Tier 2 NPS, you can access your investments without any withdrawal limits, giving you the freedom to manage your finances according to your needs.
Plus, there are no exit charges when you decide to withdraw funds from your Tier 2 NPS account, ensuring you have full control over your savings.
Guess what?
Just having an NPS Tier 1 account is not enough to open an NPS Tier 2 account. Reason? It has some other eligibility requirements. We have explained it in the next section.
(B) Eligibility to open an NPS Tier 2 Account
You need to fulfill the following criteria to open an NPS Tier 2 account-
- You must be a resident of India.
- Your age must be between 18 to 60 years.
- You must have a Tier 1 Account as well as a PRAN number. (PRAN refers to the Permanent Retire Account Number allotted to the subscribers of NPS)
- At least Rs.1000 must be deposited to open a Tier 2 account.
- After the successful completion of the process, your NPS Tier 2 account will be created.
- You must make a minimum deposit of Rs.250 in every financial year to keep your NPS Tier 2 account active.
Here you must note an important fact. Once you reach the age of 60, you won’t be able to contribute more to your NPS account. Additionally, if you want to make a withdrawal from your NPS Tier 2 account, you’ll need to apply to your Point of Presence (POP) or Service Provider (SP).
(C) How to open an NPS Tier 2 Account?
To open an NPS Tier 2 account, you have two options i.e. Online and Offline method.
| Method of Opening NPS Tier 2 Account | Steps |
| Online | Visit the eNPS website and select “National Pension System.” |
| A pop-up will appear, click on ‘Tier 2 Activation.’ | |
| Provide your PRAN number, Date of Birth, PAN number, and the Captcha on the next page. | |
| Click on ‘verify PRAN.’ | |
| Once your PRAN details are verified with your existing Tier 1 account, your Tier 2 account will be activated. | |
| Offline | Approach your Subscriber’s POP-SP to open a Tier 2 account. |
| Obtain and fill out the Annexure 1 Tier 2 information form. | |
| Submit the filled form to the POP-SP. | |
| Your bank details will be collected to link your Tier 2 account for direct withdrawals. | |
| Once the PRAN account setup is finalized, you will receive a login ID and password to access and manage your NPS account online effortlessly. |
(D) NPS Tier 2 Benefits: Why should you opt for NPS Tier 2?
Have you ever wondered, why people prefer to open an NPS Tier 2 account despite having an NPS Tier 1 account?
Does the tier 2 option offer better benefits than its tier 1 counterpart? Well, the prime reason is the alluring benefits of NPS Tier 2. We have described the major NPS Tier 2 benefits in the following table-
| NPS Tier 2 Benefits | Details |
| Flexibility | With NPS Tier 2, you have the freedom to select from various registered Pension Funds and Investment Options. You can switch between different investment options based on your financial objectives and risk tolerance. Additionally, transferring funds from NPS Tier 2 to Tier 1 is possible whenever you choose. |
| Withdrawal Flexibility | Funds deposited in your NPS Tier 2 account are accessible at any time, offering the flexibility to manage your finances according to your needs. This means you can use the account for emergency expenses or day-to-day needs without worrying about exit loads. |
| Better Returns | NPS Tier 2 allows for suitable asset allocation patterns based on your risk appetite, potentially leading to higher returns on investments. |
| Tax Benefits | While tax benefits on contributions to NPS Tier 2 are available primarily for government employees, they still make it an appealing option for many individuals. These tax benefits can significantly enhance your overall savings and investment returns. |
| Low Management Cost | NPS Tier 2 is renowned for its low-cost structure, as there are no additional annual maintenance charges. This low management cost contributes to the growth of your pension wealth over time. |
| Easily Accessible | Contributing to Tier 2 is straightforward, ensuring convenient management and regular contributions to your account. |
| Experienced Fund Managers | Your funds in NPS Tier 2 are managed by qualified and experienced professionals who adhere to approved guidelines, instilling confidence in the management of your investments. |
| Frequency of Contributions | You can deposit money into your account at your convenience, whether it’s yearly, half-yearly, quarterly, or monthly. This flexibility in contribution frequency adds to the ease of managing your account. |
| Low Initial Investments | Both Tier 1 and Tier 2 accounts can be opened with relatively small investments, making them accessible to a wide range of individuals, including freelancers and self-employed individuals. |
| Wide Coverage | NPS Tier 2 is available to all Indian citizens and NRIs who already possess a Tier 1 account. With eligibility spanning from 18 to 60 years, the scheme ensures inclusivity across various demographics. |
| Nomination | You have the option to nominate an individual to receive the account proceeds in the event of your demise, providing additional security and peace of mind. |
| Portability | The NPS Tier 2 account is portable. Subscribers can operate their accounts from anywhere, even if they move to another city or change their employment path, thanks to the vast network of PoPs. |
| No Exit Load | Unlike Tier 1 accounts, there is no exit load on withdrawals from Tier 2 accounts. This means you can withdraw your funds whenever needed without any penalty. |
| Transparency | The investment rules for Tier 2 accounts are transparent. The NPS Trust consistently monitors the performance of fund managers, ensuring accountability and reliability. |
| Voluntary Contribution | The NPS Tier 2 account is voluntary, allowing you to contribute at any point during the financial year. You can also adjust the amount you save each year. |
Now you must have understood why should you opt for NPS Tier 2. But wait! NPS Tier 2 benefits are just the golden side of the scheme. To make a wise decision, you must look at its flip side too.
(E) NPS Tier 2 Disadvantages
Now let’s look at the rough patch of NPS Tier 2 which highly contradicts NPS Tier 2 benefits-
| Disadvantages | Details |
| No Pension Payouts | Unlike Tier 1, NPS Tier 2 does not offer pension payouts upon retirement. Instead, it serves primarily to accumulate a retirement corpus. |
| Single Account Limitation | Individuals are restricted to maintaining only one NPS account throughout their lifetime, regardless of career changes or relocations. |
| No Guaranteed Returns | Returns on NPS Tier 2 are subject to market fluctuations, being generated from corporate bonds, government securities, and equity. This lack of guaranteed returns exposes the corpus to market volatility. |
| Taxability of Withdrawals | Unlike bank Fixed Deposits where only the interest is taxed, withdrawals from NPS Tier 2 are fully taxable, reducing the post-tax returns for subscribers. |
| Limited Eligibility for Tax Benefits | Tax benefits on contributions to NPS Tier 2 are exclusive to government employees, leaving private-sector employees without this advantage. |
| Tier 1 Account Requirement | A prerequisite for opening a Tier 2 account is an active NPS Tier 1 account, adding complexity to the enrollment process. |
| Limited Fund Manager Options | Subscribers have restricted options for selecting fund managers, and they cannot choose the same manager for both debt and equity funds, potentially limiting investment strategies. |
| Withdrawal Restrictions | Withdrawals from NPS Tier 2 are capped at the total sum of all contributions made by the subscriber, limiting flexibility in accessing funds. |
| Investment Restrictions | Guidelines limit subscribers from investing more than 50% of their total contributions in the NPS account, potentially restricting diversification and investment strategies. |
| Associated Risks | NPS carries various inherent risks, including credit risk, modified duration, and average maturity, necessitating subscribers to be cognizant of potential market fluctuations and associated risks. |
Don’t let the disadvantages overshadow the NPS Tier 2 benefits!
(F) NPS Tier 1 vs NPS Tier 2: Key Differences & Which One Should You Choose?
Here are the key differences between NPS Tier 1 and NPS Tier 2-
| Differential Aspects | NPS Tier 1 | NPS Tier 2 |
| Eligibility | Any Indian citizen aged 18 to 65 can open it. | Requires an active Tier 1 account. |
| Minimum Investment | Rs.500 | Rs.1,000 |
| Lock-in Period | Until the investor turns 60 | No lock-in period |
| Tax Benefits | Section 80C permits deductions up to Rs. 1,50,000 annually. Section 80CCD (1B) allows additional deductions of Rs. 50,000. | Contributions are not tax-exempted. |
| Withdrawals | First three years: No withdrawals allowed. After that: Up to 25% of the fund’s value for specific purposes. At age 60: 60% of the fund value can be withdrawn, with the remaining used to buy an annuity. | Flexible withdrawal rules; funds can be withdrawn anytime. |
| Taxation on Withdrawals | 60% of the corpus withdrawn at maturity is tax-free. The remaining funds are taxed at applicable income tax rates. | Withdrawn funds are added to income and taxed at applicable rates. |
| Fund Transfer | Funds can be moved from Tier 2 to Tier 1. EPF funds can be transferred to Tier 1. | No fund transfers are allowed from Tier 2. |
In a nutshell, Tier 1 is primarily aimed at building a robust retirement fund, whereas Tier 2 offers more flexibility for immediate financial needs.
(G) Investment into NPS Tier 2 Account
When you opt for a Tier 2 NPS Account, you’ll encounter two investment strategies viz.-
- Active Choice: With this option, you have the freedom to select from the available investment funds and allocate your investments accordingly.
- Auto Choice: Alternatively, you can choose the Auto Choice method where you simply specify your risk profile, and the scheme automatically distributes your investments across different funds based on your age and selected risk profile.
As you age, your investments are adjusted annually to gradually decrease equity exposure while increasing debt exposure. This helps safeguard your returns against market volatility.
There are four funds available for investment-
- Asset Class A: Invests in alternate instruments.
- Asset Class C: Invests in fixed-income instruments excluding government securities.
- Asset Class E: Invests in equity.
- Asset Class G: Invests solely in Government securities.
Investments in the NPS Tier 2 Account should continue until you reach the age of 60 when the scheme matures. Alternatively, you can defer the maturity by another 10 years, although further investments are not required during this deferment period.
(H) Withdrawals and Closure of Tier 2 NPS Account
If you have a Tier 2 NPS account, you can take out money whenever you need it without any restrictions. But if your Tier 1 NPS account is still active, you can’t close your Tier 2 account early. However, if you decide to close your Tier 1 account, your Tier 2 account will also be closed, and you’ll get all the money in it at once.
(I) Tax Implications on NPS Tier 2 Account
When you put money into your Tier 2 NPS account, you don’t get any tax benefits on those deposits. They’re considered part of your taxable income and will be taxed based on your income tax slab rates.
But, if you’re a Central Government employee, there’s some good news for you.
The PFRDA offers tax benefits to central government employees when they deposit in Tier 2 accounts.
Let me summarise it for you-
- You can now claim tax benefits on deposits up to Rs. 1.5 lakhs in your Tier 2 NPS account under Section 80C of the Income Tax Act, 1961. However, this deduction is only available to Central Government employees.
- Now, if you go for this tax-saving Tier 2 Account, there’s a catch. It comes with a mandatory lock-in period of 3 years. During this time, you won’t be able to withdraw any money from the account.
- As a Central Government employee, you have three NPS account options: Tier 1 (which is compulsory for everyone), Tier 2 (no tax benefits, but you can withdraw freely), and Tier 2 with tax benefits (which has the 3-year lock-in period we talked about).
- In this tax-saving Tier 2 Account, your investments will be split between different types of assets, like stocks, bonds, and money market instruments. The exact allocation is pre-decided.
- If you decide to close your Tier 1 account before the lock-in period ends for your Tier 2 account, you won’t be allowed to invest more in Tier 2. And once the lock-in period is over, your Tier 2 account will be closed too.
- You have the freedom to choose your pension fund manager, but you can only switch managers after the lock-in period.
So, if you’re thinking about investing more in the NPS scheme, opening a Tier 2 account could be a good move. It’s flexible and allows for easy withdrawals.
But remember, be aware of the tax implications, especially if you’re not a Central Government employee, as your investments will be taxable!
(J) Final Thoughts on NPS Tier 2 Benefits
In a nutshell, choosing between NPS Tier 2 and Tier 1 depends on your financial goals and preferences. Tier 2 offers flexibility with easy withdrawals but lacks pension payouts. Tier 1 provides tax benefits and a pension post-retirement.
Understanding the key differences helps you make an informed decision. If you seek short-term flexibility, Tier 2 suits you. For long-term tax benefits and retirement security, Tier 1 is the better option.
All you need to do is evaluate your needs and financial situation carefully before selecting the NPS tier that aligns with your goals!
Tier 1 seems to be a better choice as it is offering both, tax benefits and post pension benefits too.