Financial planning is fast picking up in India as more and more individuals are gaining awareness about the importance of investing and overall financial security. One of the main subjects that people have increasingly started focusing on, is retirement planning. It involves saving up and setting aside funds for the golden years of life.
To aid the country’s citizens in their retirement planning, the Government of India came up with the National Pension Scheme or NPS in 2004. When this scheme was introduced, it was exclusively meant for government employees. Later, the scheme’s framework was expanded to cover employees across sectors.
At the time of opening an NPS account, one can open a Tier 1 account before progressing to Tier 2. So, what exactly are these and how are they different from one another.
Let’s understand NPS and know the difference between Tier 1 and Tier 2 accounts.
What is NPS?
NPS is an investment that allows investors to accumulate a retirement corpus that provides annuity benefits after they reach retirement age. Contributions to NPS are voluntary. Any Indian citizen in the age group of 18 to 65 years can opt for this scheme.
It is regulated by the PFRDA (Pension Fund Regulatory and Development Authority) which comes under the purview of the Government of India.
NPS is further divided into two tiers, known as tier 1 and tier 2.
Read more: How to plan your retirement with NPS?
What is NPS Tier 1 account?
NPS Tier 1 account is a basic retirement account that has to be mandatorily opened while availing NPS benefits. With the Tier 1 account, the account holder gets a unique identification number for the NPS account in the form of a Permanent Retirement Account Number (PRAN).
Some important factors to note about the Tier 1 account are:
- An investor must make a minimum annual investment of Rs. 500 in this account.
- Post the initial investment, one can invest Rs. 1,000 or more per year to start gathering a retirement corpus.
- Once the account holder reaches 60 years of age, he/she can withdraw up to 60% of the accumulated corpus. The remaining portion is used for buying annuities such that the investor earns a regular pension.
- NPS contributions of up to Rs. 2 lakhs can be claimed for tax exemptions as per section 80C of The Income Tax Act, 1961.
What is NPS Tier 2 account?
A Tier 2 NPS account can be opened voluntarily by those who have an existing Tier 1 account. These accounts provide investors better flexibility as far as deposits and withdrawals are concerned.
Some important factors to note about the Tier 2 account are:
- To open a Tier 2 account, one must make a minimum investment of Rs. 1,000.
- In this account, there is no mandate to invest at least once a year.
- Just like any bank savings account, an investor can withdraw from Tier 2 account at any time without any restriction.
What is the difference between tier 1 and tier 2 NPS?
Let’s have a look at some of the factors that differentiate Tier 1 and Tier 2 NPS accounts:
|Tier 1||Tier 2|
|Eligibility||Any Indian citizen in the age group of 18 and 65 years can invest in Tier 1 NPS.||To open a Tier 2 NPS account, one must mandatorily have a Tier 1 NPS account.|
|Minimum contribution||Investors must make at least 1 count of contribution annually in this account.|
Minimum amount for account opening is Rs. 500.
Minimum annual contribution amount is Rs. 1,000.
|Any number of investments can be made in a year and there is no minimum number of contributions required.|
Minimum amount for account opening is Rs. 1,000.
Those who wish to make an annual contribution, a minimum amount is Rs. 250.
|Lock-in||The lock-in period is until the investor reaches 60 years of age.||No lock-in period is applicable for Tier 2 accounts.|
|Tax Benefits-||Tier 1 NPS contributions are eligible for tax deductions of up to Rs. 1.5 lakh under Section 80C and Rs. 50,000 under Section 80CCD (1B).|
No tax benefits are available for this investment.
Despite the many differences between Tier I and Tier II NPS accounts, there are also similarities as far as choices of schemes, managers and charges are concerned. Fund managers usually select similar asset classes for investing the corpus of both Tier 1 and Tier 2 accounts. Thus, depending on one’s requirement, one can choose both Tier 1 and 2 accounts or Tier 1 NPS account alone.
Although Tier 1 and Tier 2 NPS accounts are similar in structure, there are no tax benefits to be availed in Tier 2 NPS. Thus, new investors must look at Tier 2 NPS as being similar to an open-ended mutual fund since there are no withdrawal restrictions and it acts as a supplemental retirement corpus.
Tier 1 and Tier 2 NPS accounts have unique purposes. While Tier 1 account comes with many restrictions it also provides tax benefits. Tier 2 accounts do not have any withdrawal restrictions but do not provide any tax benefits either. To have a Tier 2 account, one must have a Tier 1 account. Therefore, an investor has a choice to opt for Tier 2 NPS or other options like mutual fund investments.
Yes, you can invest in both Tier 1 and Tier 2 NPS depending on your financial goals for retirement.
Yes, both Tier 1 and 2 NPS accounts invest the corpus in similar securities including equity, corporate debt, government securities and alternative investment funds.