Comparing NPS Tier 1 and Tier 2 Accounts: Understanding the Features, Advantages, Similarities, and Differences

Last Updated : March 28, 2023, 12:25 p.m.

The National Pension Scheme Tier 1 account is the culmination of your retirement planning via the National Pension Scheme route. If you are a salaried employee in the government sector, you have no choice but to open a National Pension Scheme Tier 1 account. Nonetheless, the Tier 1 account is mandatory, and the Tier 2 account is voluntary. Before choosing an account, it is necessary to know the difference between NPS Tier 1 and Tier 2 accounts.

While the National Pension Scheme is getting popular because of its low cost and numerous privileges, the account choice is confusing. Hence the article will guide you about Tier 1 and Tier 2 NPS . When investing in the National Pension Scheme, you must open a Tier 1 account before considering a Tier 2. Both accounts greatly complement each other. It is natural for you to think about the two accounts’ utility and why you can not open a Tier 2 account separately. Through the guide, you will know what is Tier 1 and Tier 2 in NPS .

What is the National Pension System?

The National Pension System is a retirement privilege plan that blends tax savings and pension payments. The National Pension Scheme offers two kinds of accounts: Tier 1 and 2. The National Pension Scheme Tier 1 is a primary account. If you are a Tier 1 account holder, you will get Permanent Retirement Account Number, whereas an NPS Tier 2 account is optional.  Account holders with Tier 1 accounts can open a Tier 2 account. The article compares between NPS Tier 1 vs Tier 2 accounts.

What is a National Pension Scheme Tier 1 Account?

The National Pension Scheme Tier 1 account is your primary account if you are a government and private sector employee. You can invest a minimum amount of Rs. 1000 in the Tier 1 account. The account is stern about withdrawals. It is an obligatory account where you contribute until your retirement.

What is an NPS Tier 2 Account?

The National Pension Scheme Tier 2 account is voluntary, and you can open it only if you are a Tier 1 account holder. The tier 2 account pretends to be like mutual funds with no lock-in period. You can contribute to the account voluntarily and withdraw your contribution at any time. Although the Tier 2 account doesn’t have stern withdrawal rules like Tier 1, in the case of the Tier 2 account, there are no tax privileges. The amount you withdraw from the Tier 2 account is added to your overall taxable income and is taxed according to the Income Tax Slab regulations.

The Tier 2 account is optional with no mandatory contribution and supplements your income post-retirement. It is flexible, independent, and liquid in nature. You can scroll down and read the differences between Tier 1 and Tier 2 NPS .

Similarities Between National Pension Scheme Tier 1 and 2 Accounts

The similarities between the Tier 1 and Tier 2 NPS are as follows:

• The charges of the NPS Tier 1 and Tier 2 are the same.
• The option of fund managers and schemes of both are similar.
• With Tier 1 and 2 NPS, you can port across Pension Fund Managers and fund choices.
• The PFM charges 0.01% on the managed assets, and the custodian charges 0.0032% on the asset’s services. The Point of Presence is accurate on all transactions when you invest money in the NPS Tier and Tier 2 accounts.

Differences Between National Pension Scheme Tier 1 and 2 Accounts

The differences between NPS Tier 1 vs Tier 2 are as follows:

• The NPS Tier 1 is mandatory, and when you open your National Pension Scheme account, it is created automatically. On the other hand, the Tier 2 NPS is optional, and you can open it anytime. If you want to open the Tier 2 account while opening the Tier 2 account, you can fill in Annexure I. However, if you want to open the Tier 2 account later, you can fill the Annexure S10 and submit it to the Point of Presence.
• Multiple tax privileges are available for Tier 1 account holders. On the other hand, there are no tax privileges when investing towards Tier 2 accounts.
• A lock-in period is available for Tier 1 accounts. Your investment in the Tier 1 account is locked in till you reach sixty years. On the other hand, there’s no lock-in period for funds in the Tier 2 account. The Tier 2 account is voluntary, with adjustable withdrawal and exit rules. You can withdraw anytime from the Tier 2 account.
• The subscription to the National Pension Scheme begins with the Tier 1 account opening, which comes with a Permanent Retirement Account Number. On the other hand, you can open a Tier 2 account only if you are a holder of a Tier 1 account.
• Under the Tier 1 account, you can save, invest, and claim tax deductions under the regulations of the Income Tax Act. Since there are no tax benefits in Tier 2, you can not claim tax deductions.

Privileges of Investing in Tier 1 and 2 Accounts

Some privileges of investing in NPS Tier 1 and Tier 2 accounts are as follows:

• Your contributions towards the National Pension Scheme are eligible for tax deductions under the 80CCD section of the Income Tax Act of 1961.
• You can select your asset allocation and explore different fund options.
• You can contribute any minimum amount towards the National Pension Scheme.
• Expert fund managers manage the National Pension Scheme to maximise returns and minimise risks.

Which Option Can You Opt for, Tier 1 or Tier 2?

After minutely going through the differences between NPS Tier 1 vs Tier 2 accounts, you have an idea about the merits and demerits. Hence, before investing in NPS, you can consider the following factors:

• Unlike the NPS Tier 2 account, the Tier 1 account has fewer opportunities to meet financial emergencies.
• The Tier 2 account is similar to a savings bank account, and the Tier 1 account is rigid.
• At the investment and maturity phases, you enjoy more tax privileges in the Tier 1 account than in Tier 2.
• The Tier 2 account enhances your retirement corpus with extreme flexibility.
• The Tier 1 account aids you in building your corpus for retirement, and Tier 2 pretends to be a supplement.
• You can withdraw funds prematurely from Tier 2 accounts whenever you want, but Tier 1 accounts have a few restrictions.

The National Pension Scheme can be a good choice if you want to save for post-retirement life and enjoy tax privileges. It is important to think carefully about your investment principles and risk tolerance before deciding whether the National Pension Scheme is appropriate.

Conclusion

While both NPS Tier 1 and Tier 2 accounts have many similarities, the two accounts differ in investor flexibility and tax incentives. Suppose you are a new investor. In that case, a National Pension Scheme Tier 1 account might be suitable to create a corpus for retirement.  The National Pension Scheme Tier 1 account is a low-investment scheme that offers multiple tax privileges. On the other hand, if you wish to open a National Pension Scheme Tier 2 account, it would be best to have a National Pension Scheme Tier 1 account. Before opening an account, it is necessary to know all the factors.