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Types of National Pension Scheme (NPS) Accounts
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Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.
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NPS is a government-backed program offering retirement planning and tax-saving benefits. Under the supervision of the Pension Fund Regulatory and Development Authority (PFRDA), the scheme helps investors amass a substantial retirement fund and reduce tax obligations. There are two types of NPS accounts – Tier 1 and Tier 2. While a Tier 1 account is ideal for retirement planning with tax benefits, Tier 2 is a voluntary account with more flexibility.
Here's a detailed look at the Tier 1 and 2 account types.
Types of NPS Accounts
Let’s talk about the two types of NPS accounts.
Tier 1 is the mandatory and basic account type in NPS that helps save money for retirement. Account holders cannot withdraw money from it before superannuation, except under inevitable conditions like critical illness, house purchase, child’s education or marriage, start-up investment, etc. Upon retirement, the subscriber can withdraw 60% of the accumulated corpus in a lump sum and purchase an annuity with the remaining 40%. Based on this investment, they receive a regular pension for life.
Investments under the NPS Tier 1 scheme types are tax-deductible up to Rs. 2 Lakh per year under Section 80C according to the old tax regime. Therefore, it is a reliable tax-saving and retirement planning scheme similar to EPF and PPF. An account holder receives a PRAN after contributing Rs. 500 to the account and retains the account by depositing at least Rs. 1,000 per annum. There is no limit to the maximum amount one may deposit in an NPS account.
Tier 2 is a voluntary account type in NPS. Existing Tier 1 account holders can open a Tier 2 account without hassle. This type of NPS account is more flexible than NPS Tier 1 scheme types, as it allows subscribers to deposit and withdraw funds at any time per their convenience. However, one drawback is that investments in a Tier 2 account offer no tax deductions for self-employed and private-sector personnel.
An individual can open a Tier 2 NPS account by contributing a minimum of Rs. 250. It does not impose any minimum contribution requirements, making it more flexible and convenient for account holders. However, the investment choices and fund management costs are similar for both NPS scheme types.
Similarities Between Tier 1 and Tier 2 NPS Accounts
There are several similarities between Tier 1 and Tier 2 NPS accounts. Let’s look at them:
Charges
The fund management charges and other associated fees are similar for both types of NPS accounts.
Asset Classes
With both types of NPS schemes, subscribers may invest in similar asset classes like equity, government securities, and corporate bonds.
Porting Facility
Subscribers can conveniently port across fund options and PFMs with any type of account.
POP Charges
The POP charges service charges and other charges on assets. The POP charges for both types of NPS accounts are the same.
Maximum Contribution
Both types of NPS accounts have no limit to the maximum contribution amount.
Benefits of Investing in NPS Tier 1 & Tier 2
Here’s a look at the benefits of both account types and different schemes in NPS so you can make an informed choice:
Parameter
Tier 1 Account
Tier 2 Account
Purpose
Retirement saving
Regular saving
Eligibility
Any individual between 18 and 70 can open a Tier 1 NPS account
Any individual holding a Tier 1 NPS account can open a Tier 2 account
Lock-in Period
Till 60 years or superannuation
No lock-in period
Withdrawal
Only after 60 years or specific inevitable conditions
Allows withdrawal at any time
Tax Benefits
Tax deduction of up to Rs. 1.5 Lakh under Section 80CCD and an additional deduction up to Rs. 50,000 under Section 80CCD (1B)
No tax benefits
Investment Choice
Active and Auto
Active and Auto
Partial Withdrawal
Only up to 25% after completing at least three years in the scheme
No conditions attached to a premature withdrawal
Should You Choose a Tier 2 NPS Account or a Tier 1 NPS Account?
Different NPS schemes and account types have both pros and cons. While Tier 1 is an excellent investment option for retirement planning, Tier 2 is a better scheme for regular investment due to its greater flexibility. The primary difference between them lies in the withdrawal rules. While a Tier 1 account allows withdrawal only at superannuation except in certain emergencies, a Tier 2 account allows withdrawal at any time without any conditions.
Another major difference lies in the annuity income. A Tier 1 account is better for individuals looking for a regular annuity income after retirement. Unlike a Tier 2 account, a Tier 1 account also offers tax benefits. Ultimately, the final choice between NPS schemes depends on the subscriber’s investment preferences, flexibility level expected, and financial goals.
Frequently Asked Questions
Q: Do I need a Tier 1 account to open a Tier 2 account?
Yes, only Tier 1 NPS account holders are eligible to open a Tier 2 NPS account.
Q: Is the National Pension Scheme a safe investment option?
The PFRDA is a government regulatory body that oversees the NPS guidelines, compliance, and operations. Therefore, investing in different NPS schemes is a safe investment option.
Q: What are Tier 1 and Tier 2 NPS accounts meant for?
Tier 1 accounts are meant for salaried and self-employed individuals planning to save money for their retirement and receive a regular monthly pension during their golden years. Tier 2 NPS accounts are meant for Tier 1 account holders looking for more flexibility.
Q: Will a private sector employee receive tax exemption under a Tier 2 NPS account?
Tier 2 NPS accounts do not offer tax benefits to the subscribers.
Q: Is a Tier 1 NPS account compulsory to open?
Tier 1 NPS account is an investment scheme that benefits people with retirement funds and tax deductions. The option to open an account depends on the investor’s financial goals and objectives. It is not compulsory.
Q: Can I change from one Pension Fund Manager and investment plan to another, and if it is possible, how?
Yes, changing the investment plans and PFMs is possible. To do that, one must log in to their NPS account, select ‘Change Scheme Preferences’, and select their preferred options.
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