NPS Account Tier 1 Vs. Tier 2

The government of India introduced National Pension System for its employees in 2004, replacing the existing pension scheme. Subsequently, the enlarged ambit covers the salaried and the self-employed as well from May 2009. The scheme is designed to fulfill the government’s social obligation by extending old age security coverage to its citizens. The system ensures retirement income through long-term market-based returns on the accumulated corpus in a defined architecture comprising Tier 1 and Tier 2 accounts.  These accounts are the lifeline of the system that you must know, regardless of your professional status.

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What is the Meaning of Tier 1 and Tier 2 Accounts in NPS?

The entire scheme revolves around the two account types with varying connotations for the subscriber.  You contribute to the accounts during your earning years to reap the benefits of the corpus as you retire at sixty years of age. The Tier 1 account is mandatory where you contribute till you retire. The Tier 2 account, on the other hand, is optional with no compulsion to contribute but supplements your retirement corpus. 

The primary difference is that the Tier 1 account is rigid about withdrawals while the Tier 2 account is flexible and liquid. 

NPS Account Tier 1 Vs. Tier 2 – Subscription

The Pension Fund Regulatory and Development Authority (PFRDA) is the NPS’s governing body, while the NSDL is the Central Recordkeeping Agency (CRA). The CRA generates the unique Permanent Retirement Account Number (PRAN) for each subscriber acting as the ID maintained in its database. The NPS operates through well-defined models structured on the subscriber class. Check where you belong:

  • Government Model: Covers all Central and State Government employees barring the Armed Forces.

  • Corporate Model: Covers public and private sector employees.

  • All Citizens Model: Any citizen of India can volunteer to join the system. 

The subscription to NPS is determined by the model you belong to, and the available options are:

  • Nodal Officers: Employers and Government employees

  • POP-SP (Points of Presence – Service Provider):   Corporate Employees

  • POS-SP or eNPS: Other individual subscribers by using the PAN Card and bank account credentials.

Difference Between NPS Account Tier 1 Vs. Tier 2

You are eligible to subscribe to the NPS if you are an Indian citizen between 18 and 65 years of age. Since 1 May 2009, there has been no bar on joining the scheme even if you are self-employed. The differences between these two accounts are:

Parameter Tier – 1 Account Tier – 2 Account
Eligibility Opening the account is mandatory if you want to enjoy the benefits of NPS. The prerequisite is that you must have subscribed for NPS membership and possess a valid PRAN. The account is optional, but you can open it only after opening the Tier 1 account.
Contribution You open the account with Rs.500 and deposit a minimum of Rs.1000 every year to continue your membership.  The salaried contribute a compulsory 10% of their basic pay, and the employer an equal amount every month. However, the Central Government contributes 14% of the employee’s monthly basic pay. You are under no compulsion to contribute regularly to the account. It is an open-access account where you contribute a minimum of Rs.1000 initially to get going. But consider a subscription to the account in place of the Mutual Fund Systematic Investment Plan (SIP) as a first-time investor to save and earn market-linked returns.
Lock-in Period The fund is locked in the account until you reach sixty years, considered the retirement age. Your fund is not locked in, and you can withdraw the accumulated balance in full or partially, according to your convenience.
Return on Investment The NPS corpus grows based on the long-term returns earned in Tier 1 and Tier 2 accounts. Beginning from the Pension Fund Manager (PFM) selection, your role is crucial. The return under NPS is market-driven, depending on the PFM’s fund allocation. Therefore, you must not expect a fixed return, but a record of 9% to 15% makes it a safe investment vehicle. The PFM declares the Net Asset Value (NAV) at the day-end, and units are credited to your NPS accounts. It implies that you do not access the returns by way of dividend or bonus, for which the withdrawal rules apply.
Tax Benefits On Investment: You are eligible for tax deduction under Section 80CCD of the Income Tax Act, 1961. 
  • 80CCD (1):  Permitted deduction is 10% of your monthly income if you are salaried and 20% for the self-employed, limited to a maximum of Rs.1.5 Lac. **
  • 80CCD (1B): A maximum of Rs.50000, regardless of your profession. ##
  • 80CCD (2):  Your employer’s contribution is up to 10% of your salary over and above 80DCCD (1). The deduction is 14% for central government employees. @@

**Within the overall limit of Rs.1.5 Lac deduction under Section 80C. ## Over and above the deduction under Section 80C. @@ Over and above the deduction under Section 80C
On Investment: You do not enjoy any tax deduction for contributing to the account.
On Maturity: You can withdraw 60% of the corpus on retirement, and the remaining 40% is used to purchase an annuity plan.  The entire withdrawal amount is tax-exempt. On Maturity: Not specified for the corpus in this account.

*All savings are provided by the insurer as per the IRDAI approved insurance plan. Standard T&C Apply

“Tax benefit is subject to changes in tax laws. Standard T&C apply.”

NPS account Tier 1 Vs. Tier 2 – Which to Choose?

Having gone through the comparison between the NPS Tier 1 and Tier 2 accounts, you must have a grasp of the pros and cons. In addition, your careful consideration must factor the following:

  • The Tier 1 account provides fewer opportunities to meet financial emergencies, unlike the Tier 2 account.

  • While the Tier 1 account is rigid, the Tier 2 account is similar to operating a savings bank account. 

  • You enjoy more significant tax benefits with the Tier 1 account than the Tier 2 account at the investment and maturity phases. 

  • However, the Tier 2 account augments your retirement corpus with extreme flexibility.

In Conclusion 

The Tier 1 account is the clincher in your retirement planning through the NPS route. For the salaried, especially in the government sector, you do not have a choice but open a Tier 1 account. However, the compulsory Tier 1 and the voluntary Tier 2 accounts complement each other functionally.   However, the accounts differ widely in terms of flexibility while fulfilling the long-term objective. So, consider all these factors and choose wisely.

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