Understand Tier 1 Vs Tier 2 Account? Should you opt Tier 2 NPS Account?

While NPS is slowly gaining popularity thanks to its low cost and host of tax-benefits, the choice of accounts offered in NPS tends to cause a lot of confusion at the time of investing.

When you want to invest in NPS, you first need to open an account under the Tier I before you can consider opening the Tier 2 account. It’s natural for people to wonder about the utility of two different accounts and why the Tier 2 account cannot be opened independently. You will be able to know the benefits of both accounts and should you go for the Tier 2 account later in this blog post.

Read: NPS: Everything you need to know

What Is Tier 1 In NPS

The National Pension System (NPS) is a defined contribution pension scheme that allows individuals to save for their retirement. It is administered by the Pension Fund Regulatory and Development Authority (PFRDA).

NPS Tier 1 accounts are the primary accounts for employees working in the government and private sectors. Investors can invest starting Rs 1,000 a year in these accounts.

With NPS, individuals can choose various investment options for their retirement savings, including equity, corporate bonds, and government securities.

NPS also offers tax-free investment returns and tax benefits for contributions made under section 80C of the Income Tax Act.

Under specific circumstances, it is possible to make partial withdrawals from an NPS Tier 1 account.

What Is Tier 2 In NPS?

Tier 2 is a voluntary account that can be opened by individuals who already have a Tier 1 account. These accounts act like mutual funds with no lock-in period. Contributions to Tier 2 accounts are voluntary and can be withdrawn at any time.

While there are no withdrawal rules, Tier 2 accounts do not enjoy any of the tax benefits. The withdrawals from Tier 2 accounts are added to the individual’s total taxable income and are taxed as per the income tax slab.

NPS Tier 1 And Tier 2 : The Similarities

There are multiple similarities between Tier I and Tier 2 NPS accounts.

Tier 1 and Tier 2 NPS accounts have similar charges and choices of fund managers and fund schemes.
The asset classes in which the fund managers can invest are also the same.
The Pension Fund Manager (PFM) charges 0.01% on the assets managed, and the custodian charges 0.0032% as an asset servicing charge. The POP has the exact charge on every transaction when you put money in Tier 1 or Tier 2 NPS.
You can also port across PFMs and fund options with NPS Tier 1 and 2.

NPS Tier 1 Vs Tier 2: What is the Difference?

In functionality, both Tier 1 and Tier 2 are similar, and so are the fund management costs as well as the choice of investments.

Even though NPS Tier 2 works exactly like your NPS Tier I account, there are certain differences.

NPS Tier 1	NPS Tier 2
The subscription to NPS starts with the opening of the Tier 1 account, which comes with a PRAN (Permanent Retirement Account Number).	You can open the NPS Tier 2 account only when you already have a Tier 1 account.
Your investment in the NPS Tier 1 account is locked in until the age of 60.	Tier 2 account is a voluntary account with flexible withdrawal and exit rules.
Before the age of 60, you can make partial withdrawals for specific purposes or go in for a premature exit (as explained below).	Unlike the Tier 1 account, there is no lock-in with savings in the Tier 2 account. You can withdraw from the Tier 2 account at any time.
Under NPS Tier 1, you can save and invest to claim the tax deductions available under version sections of the Income Tax.	Contribution to Tier 2 NPS has no tax benefits – you can’t claim deductions, and the corpus is taxed on exit.

What are the Benefits of Investing in NPS Tier 1 & Tier 2?

NPS is a pension scheme designed to provide individuals with retirement benefits. Here are some of the benefits of investing in NPS;

Tax benefits: Contributions to NPS are eligible for tax deductions under section 80CCD of the Income Tax Act.
Flexibility: Investors can choose their own asset allocation and have the option to switch between different fund options.
Affordability: NPS has low minimum contribution requirements, making it accessible to a wide range of investors.
Professional management: NPS is managed by professional fund managers who aim to maximize returns while minimizing risks.

Overall, NPS can be a good option for individuals looking to save for their retirement and take advantage of tax benefits. It is important to carefully consider your investment goals and risk tolerance before deciding whether NPS is the right option for you.

Tax Benefits on NPS Tier 1 & Tier 2 Returns

The contributions made to an NPS Tier 1 account are eligible for tax deductions. Contributions to an NPS Tier 2 account do not offer any tax benefits.

Tax Benefits under Section 80C: The deduction limit for this section is Rs. 1.5 lakhs. You can invest the entire amount in NPS and claim the deduction if you wish.
Tax Benefits under Section 80CCD (1B): NPS investors get this additional tax benefit. Under this section, you can claim tax deductions for your investments up to Rs 50,000. You can claim this over and above the deduction under Section 80C.

So, you can claim tax deduction up to Rs 2 lakh by investing in NPS – Rs 1.5 lakh under Section 80C and another Rs 50,000 under Section 80CCD (1B). That means if you fall under the tax bracket of 30%, you can save Rs 62,400 in taxes.

Tax Benefits under Section 80CCD (2): Under this section, benefits can only be availed on the contributions made by the employer. Hence, this is meant for the salaried individual and not self-employed.

Should You Opt for NPS Tier 2?

You know that structurally, all aspects of Tier 1 and Tier 2 NPS are the same. The choice of the available asset class to invest, option among fund manager and charges are also same. Yet there is a case to invest in Tier 2 NPS sans the tax benefits. The reason: if you are new to investing and have a Tier 1 NPS account, you could consider NPS Tier 2 as an open-ended mutual fund to invest towards any surplus savings.

The limited equity exposure of up to 75% in the case of NPS, limits the risk of volatility with equity, which is much desired by first-time investors. Moreover, you can benefit from the low investment cost as the Pension Fund Manager (PFM) charges is 0.01% on the assets managed and the overall cost of the NPS is the lowest compared to mutual funds. With no lock-in, the flexibility to withdraw from Tier 2 account allows you to dip into the savings in the account whenever you need, which makes the case to invest in Tier 2 NPS.

FAQ Related To NPS Tier 1 & Tier 2

Can I have a different Pension Fund Manager and Investment Option for my Tier 1 and Tier 2 account?

Yes, you have the option to choose different pension fund managers (PFMs), and investment options for your National Pension System (NPS) Tier 1 and Tier 2 account.

Can I appoint nominees for the NPS Tier 1 and Tier 2 Account?

When opening an NPS account, you need to appoint a nominee by filling out the designated section of the registration form. Up to three nominees can be appointed for both NPS Tier 1 and NPS Tier 2 accounts.

Can I switch from one investment scheme to another Pension Fund Manager, and if so, how?

As a subscriber, you can change the Pension Fund Manager. Currently, you can do so once per Financial Year.

To submit your request, you have two options:

Option 1: Visit the eNPS website and submit your request online.

Option 2: Go to a Point-of-Presence outlet and physically submit form no. (UOS-S3/CS-S3).

After your request is processed, you will receive an email at your registered email id through the CRA system.

How can a Tier 2 account be defined?

A Tier 2 account is a voluntary account that allows account holders to perform basic banking transactions such as deposits and withdrawals. Unlike a Tier 1 account, a Tier 2 account does not have mandatory withdrawal requirements and does not offer tax benefits.

What are the benefits of a Tier 2 account?

Here are some benefits of a Tier 2 NPS Account;

No annual maintenance fees
Flexibility to withdraw funds for daily expenses at any time
Ability to transfer funds to a Tier 1 pension account at any point
No minimum balance requirement
No exit load
Option to assign a separate nominee
Choice of different investment options from Tier 1.

Can I open NPS Tier 2 through offline mode?

Yes, any person who has an active Tier 1 account can apply for a Tier 2 account.

The registration form for joining NPS can be collected from any of the Point of Presence-Service Providers (POP-SP).

It can also be downloaded from the NSDL website and sent it duly filled to the POP-SP.

Can You Invest in Tier 1 and Tier 2 Accounts Simultaneously?

You can open the NPS Tier 2 account only when you already have a Tier 1 account. Tier 2 account is a voluntary account with flexible withdrawal and exit rules.

What happens to NPS Tier 1 balance if the investor passes away before 60?

Upon the death of the Subscriber, the entire accumulated pension wealth (100% NPS Corpus) will be given to the Subscriber’s Nominees or Legal heirs, as the case may be, of such Subscriber.

What is the role of a fund manager for a Tier 1 and Tier 2 NPS account?

The role of a fund manager for an NPS account is to manage the investment portfolio of the subscriber’s pension fund. This involves making decisions about which financial assets to invest in to maximise the potential return on the investment. The fund manager is also responsible for monitoring the portfolio’s performance and making adjustments as needed to ensure that it remains in line with the investment goals of the subscriber.

How the withdrawal from NPS tier 2 is taxed? Is any indexation or tax on only capital gain will be available?

Withdrawals from NPS Tier 2 are taxed at 20% after indexation if held for more than 36 months. If the units are redeemed within 36 months, the profits from the redemption will be considered short-term capital gains and will be included in the subscriber’s regular income, which will be taxed at the rate applicable to their total income.

In the Tier 1 account, how to select the option of lumpsum or SIP?

Depending on your financial capabilities, you can either make a lump-sum payment or start a Systematic Investment Plan (SIP) through ET Money.

Is it possible to maintain both Tier1 and Tier 2 under a single account and contribute partially to both?

While people generally invest in either a Tier 1 or a Tier 2 account, it is possible to simultaneously have investments in both a Tier 1 and a Tier 2 accounts.