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How Do NPS Tier 1 And Tier 2 Accounts Differ? Who Should Invest In The Latter?

There is no maximum contribution limit in NPS Tier 1 and Tier 2 accounts; however, contributions to Tier 1 accounts get up to Rs 2 lakh deductions under the Income Tax Act.

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Outlook Money
November 30, 2023
NPS Tier 1 And Tier 2 Account

NPS Tier 1 And Tier 2 Account

The National Pension System (NPS) is a government-aided long-term savings plan for retirement. NPS has two types of accounts, Tier 1 and Tier 2, and people often get confused about which of these accounts is suitable for whom. However, there are some apparent differences between NPS Tier 1 And Tier 2 Account regarding their features and purposes.

Key Differences of an NPS Tier 1 and Tier 2 Account

Tier 1 account is a retirement savings plan, whereas the Tier 2 account is a common investment plan. Any Indian citizen, including resident and non-resident Indians, between 18 and 70 years of age can open a Tier 1 account; in Tier 2, the applicant must be enrolled in Tier 1 to be eligible.

Also, the lock-in period in a Tier 1 account is 60 years, whereas a Tier 2 account has no lock-in. For withdrawals, a Tier 1 account holder can draw funds after reaching 60, but in Tier 2, the subscriber can withdraw at any time.

There is no maximum contribution limit in either account; however, contributions to Tier 1 accounts get up to a Rs 1.5 lakh deduction under Section 80CCD (1) and an additional Rs 50,000 under Section 80CCD (1B). On maturity, the Tier 1 account holder can withdraw up to 60 percent of the corpus in a lump sum, tax-free, while the rest of the balance is used for buying an annuity plan. There is no maturity period for Tier 2 accounts. In addition, there is the active and auto investing option in a Tier 1 account; for Tier 2 account holders, only the active option is available. Moreover, Tier 2 account holders are not obligated to buy an annuity plan after 60.

Another vital difference is regarding partial withdrawals. A Tier 1 account holder can make partial withdrawals up to 25 percent of the invested corpus three times until maturity, allowed after completing three years of account opening. There is no such restriction in a Tier 2 account. Unlike a Tier 1 account, Tier 2 accounts do not enjoy tax benefits. The account withdrawals are added to the individual’s taxable income and are taxed as per their income tax slab.

Who Should Opt for the NPS Tier 2 Account?

There is no clear winner or loser here. Both schemes have certain advantages and disadvantages. The choice will depend on the individual’s income, financial goals, and risk-taking ability. For instance, a government employee may opt for a Tier 1 account for regular income post-retirement, whereas others may select other small savings schemes, like the Public Provident Fund (PPF), for retirement planning. Also, some may opt for Tier 2 in addition to Tier 1 as an open-ended mutual fund for surplus savings, which perhaps has the lowest expense ratio than other funds.

In any case, the NPS’s limited exposure to equity, up to 75 percent in both tiers, makes it an ideal investment tool for risk-averse individuals looking for stable income.

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