All About NPS Tier 2 & Tier 1 Accounts?

Written by : Knowledge Centre Team

2024-08-02

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National pension scheme or NPS is one of the best retirement solutions from the government of India. The primary purpose of NPS is the retirement savings, however, you can also invest in NPS for growth and short-term goals.

NPS offers two categories of accounts as of now:

Tier 1 Account: Meant for retirement savings for govt and private sector employees along with other Indian citizens
Tier 2 Account: Meant for general investment

The Retirement Account – Tier 1 Account

Tier 1 account is made specifically for retirement purpose. However, it does allow partial withdrawals for special occasions in life. More than that, the account offers the best tax-savings for investors.

Here are the salient features of Tier 1 NPS account:

Who can Invest?

Any Indian citizen is allowed to subscribe to this account as soon as he/she reaches the age of 18. Maximum age of entering NPS Tier-1 account is 60.

How much Can You Invest?

There is no upper limit for investment, although tax benefits will only apply to a limited amount based on your income. Also, contribution to NPS is compulsory for government employees, while private-sector employees have a choice.

However, as a self-employed person you can invest as much as you like out of your income (though, tax laws may not fully agree. Check the taxation part for details).

The minimum contribution to Tier-1 account has to be at least Rs. 500 per transaction and at least Rs 6000 per year. Also, you need to invest at least once in a financial year.

What about Withdrawals from Tier-1 Account?

You can withdraw the funds from Tier-1 NPS account upon retirement, resignation or in the case of death, your family members can withdraw. However, in case of resignation before the age of 60 you can only withdraw up to 20% of the corpus in a lump sum, rest should be invested in an immediate annuity account for a pension.

You can also withdraw partially before maturity or resignation, but only after you have stayed invested for at least 10 years. You can withdraw only up to 25% of the corpus built from your own contributions under the following circumstances:

Higher education and marriage of your child, including the one, legally adopted
Purchase of the first house property
Treatment of any of the specified life-threatening diseases such as cancer, kidney failure, heart surgeries, etc.

Tax Savings: The account helps you save tax at the time of investment and at the time of maturity.

At the Time of Investment: Up to Rs. 2 lakhs

Employer Contribution:For private-sector employees, the contribution from the employer is tax-exempt if up to 10% of basic + DA. However, government employees can have up to 14% contribution tax-free from their employer.
Self-Contribution: Contribution of up to Rs. 1.5 lakhs in a financial year is exempt from tax. However, the contribution over 10% of Basic + DA salary will not be counted for the deduction. But, if the 10% of your basic + DA is more than 1.5 lakhs, or you have invested additional amount you can claim another Rs. 50,000 as a deduction under section 80CCD(1B).

At the time of Maturity: Normally 60:40, Otherwise 20:80

Withdrawing Before 60: If you are withdrawing before the age of 60, as in the case of resignation. You can only withdraw up to 20% of the corpus in lumpsum. You need to annuitize the rest of the corpus for a regular income; that is, invest the sum in an immediate annuity plan.
Withdrawing at or after 60: The NPS Tier 1 account matures once you reach the age of 60. At maturity, you have two options – withdraw or stay invested. If you want to withdraw any time after 60, you can withdraw only up to 60% of the corpus in a lump sum, free from tax. The remaining must be invested into an immediate annuity plan.’

Partial Withdrawals: 25% Only

Partial withdrawals from the NPS Tier-1 account is only exempt on up to 25% of own contribution. Anything more will get added to your taxable income for the year.

Asset Allocation in Tier 1 Account

Five Asset Choices: You can invest your retirement savings in a mix of these assets – Equity, Corporate debt, Government Debt, Alternate Assets like gold and real estate.
Limits to the Asset Class: Your maximum equity allocation cannot exceed 75% of your total portfolio. the maximum allocation to the alternate asset will be limited to 5%.
Limits to Choice of Allocation: You can either choose one of the automatic lifecycle-based portfolios or manually decide the ratios of asset allocation. In case you want to decide the asset allocation, it’ll be subject to the conditions above only until the age of 50.

After 50 your equity allocation starts to decline and by the age of 60, you cannot have more than 50% of your portfolio into an equity fund.

Automatic Portfolio Management: NPS account offers automated portfolio management based on your age and risk appetite. You have three lifecycle portfolio choices in the declining risk order:

LC75 – Aggressive Lifecycle Fund: Maximum equity allocation 75% up to the maximum age of 35
LC50 – Moderate Lifecycle Fund: Maximum equity allocation 50% up to the maximum age of 35
LC30 – Conservative Lifecycle Fund: Maximum equity allocation 30% up to the maximum age of 35

After the age of 35, your equity and corporate debt allocation start to decline while allocation to government debt securities grows.

Investment Account – Tier 2 Account

Tier 2 NPS account is an open-access account with all the investment benefits except tax-saving and lock-in hurdles as Tier 1 account. Only limits in the Tier 2 NPS account is for a minimum investment in a year, which has to be as given below:

The account can be started with a minimum contribution of Rs. 1000
Minimum one contribution of Rs. 250 per year is required
Minimum account balance at the end of a financial year should be Rs. 2000

Taxation of NPS Tier-2 Account

There is no limit to how much you can save or withdraw from the account or when. However, there are no tax benefits either. Upon withdrawal, the gains on your investments are added to your taxable income of the year and taxed as per the slab rates.

The Option of Tax-Saving for Government Employees

In recent budget announcements, the finance minister announced the tax saving under section 80C for Tier-2 NPS account to government employees. However, the scheme has not been notified as yet.

Few rules which are clear, however, tell us that if you opt for 80C deduction on your NPS Tier 2 account you will have a lock-in period of 3 years. The rules do not say anything about the tax on maturity value from such contribution. Thus, we can assume that maturity will still be taxable as per slab rates.

The deduction is not available to private-sector employees or individual contributors.

Similar Retirement Investment Plans

The only retirement investment plan which comes close to matching the prowess of NPS Tier-1 account is unit-linked insurance plans (ULIPs). However, more conservative investors can also consider pension plans from life insurance providers.

Life insurance pension plans have similar asset allocation profiles as the conservative lifecycle fund. However, if you are an aggressive investor, and want to build a tax-free pension, ULIPs could be your friend.

Equipped with automated portfolio management strategies and tax-free systematic withdrawals up to the age of 100, you will not need anything else.

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