The National Pension System (NPS), a voluntary retirement savings scheme governed by the Pension Fund Regulatory and Development Authority (PFRDA), enables individuals to build up their tax-efficient retirement corpus through market-linked investments.
Investors can open and manage an NPS account using a Tier-1 or Tier-2 account.
The Tier-1 account is a mandatory pension account, whereas the other one is a voluntary/optional account with unrestricted withdrawal benefits.
But do you know what the core differences are between the two options and which is the best option for you?
Eligibility and difference between NPS Tier-1 and Tier-2 accounts
Anyone eligible to open an NPS account can open a Tier I account, which is the primary retirement-savings account. A Tier II account can only be opened if you already have an active Tier I account.
The choice ultimately depends on your financial goal. If someone is looking to build a long-term retirement corpus and benefit from the applicable tax advantages, Tier I is more suitable. If they already have Tier I and want a more flexible investment option with easier access to their money, Tier II may be a better fit.
The Tier I NPS is primarily a retirement savings account that has certain restrictions on withdrawals and offers tax benefits. Tier II is a more flexible investment account, where customers can withdraw their money as per the applicable rules.
Both Tier 1 & Tier 2 accounts offer market-linked investments and allow subscribers to choose investment options and Pension Fund Managers. The key difference is that Tier I is retirement-focused with withdrawal restrictions, while Tier II offers greater liquidity.
Minimum contribution and taxation
The minimum contribution under Tier I is Rs 500 per transaction and Rs 1,000 per financial year, while Tier II requires a minimum contribution of Rs 250 per transaction and has no restrictions on minimum contribution per year. There is generally no maximum contribution limit for either account.
If the minimum annual contribution requirement for Tier I is not met, the account may be frozen until the required contribution is made. Tier II does not have a comparable annual minimum contribution requirement.
Tier I contributions can offer tax benefits under applicable provisions, making it more attractive for those looking to save for retirement while also getting tax benefits. Tier II generally doesn’t offer tax benefits for non-government subscribers, so it is primarily suited for those who value greater flexibility in accessing their investments.
Employees contributing to the National Pension System (NPS) can claim tax deductions on their own contributions, subject to applicable limits. Under Section 80CCD(1), employees can claim a deduction of up to 10% of salary (Basic + DA). This deduction is included within the overall Rs 1.50 lakh limit under Section 80CCE.
In addition, Section 80CCD(1B) allows employees to claim an additional deduction of up to Rs 50,000 for their NPS contributions. This benefit is available over and above the Rs 1.50 lakh limit under Section 80CCE, subject to applicable conditions.
Employer contributions to an employee’s NPS account are eligible for a separate tax benefit under Section 80CCD(2). Under the old tax regime, the deduction is available on employer contributions of up to 10% of salary (Basic + DA). For employees opting for the new tax regime, the deduction limit is higher at 14% of salary (Basic + DA).
For self-employed individuals, Section 80CCD(1) provides for a deduction of up to 20% of gross total income, subject to the overall Rs 1.50 lakh limit under Section 80CCE. The additional deduction of up to Rs 50,000 under Section 80CCD(1B) may also be claimed, subject to the applicable provisions.
Partial withdrawals from an NPS account can qualify for tax exemption, subject to the applicable conditions. Under Section 10(12B), an eligible subscriber can claim tax exemption on withdrawals of up to 25% of their own contributions to the NPS account. Such withdrawals are permitted subject to the terms and conditions specified by the Pension Fund Regulatory and Development Authority (PFRDA).
At the time of exit from NPS, the amount used to purchase an annuity is eligible for tax exemption under Section 80CCD(5). However, the pension or other income subsequently received from the annuity is taxable in the hands of the subscriber under Section 80CCD(3), as per the applicable tax provisions.
Subscribers are also eligible for tax exemption on the lump-sum withdrawal of up to 60% of the accumulated pension wealth upon attaining the age of 60 or superannuation. This exemption is available under Section 10(12A), subject to the applicable NPS exit rules.
Employer contributions of up to 14% of the employee’s salary, comprising Basic + DA, can be treated as a business expense and claimed as a deduction under Section 36(1)(iv)(a) of the Income Tax Act, 1961, subject to the applicable provisions.
Withdrawal and exit rules
| Particulars | Withdrawal and exit rules for Tier-1 |
| Entry and Exit Age | Entry and exit age increased to 85 years. |
| Lock-in period | All Citizen Model (CS & MSF):5-year minimum subscription (lock-in) period removed. |
| Normal Exit – After 60 years or 15 years | All Citizen Model (CS & MSF): Vesting period → 15 years or any higher period stipulated under a scheme; or till 60 years of age (whichever is earlier). |
| Normal Exit – After 60 years or 15 years | Up to 80% lump sum; At least 20% annuity |
| Normal Exit – After 60 years or 15 years | I) For corpus up to Rs 12 lakh: a) ≤ Rs 8 lakh → 100% lump sum or SLW or SUR or other approved options.b) > Rs 8 lakh ≤ Rs 12 lakh → Up to Rs 6 lakh as lump sum; Balance as SUR for min. 6 years or annuity.II) For any corpus → Up to 80% lump sum & at least 20% annuity applies. |
| Premature Exit – Before 60 years or 15 years | Up to 20% lump sum; At least 80% annuity; (remains the same) |
| Premature Exit – Before 60 years or 15 years | For corpus ≤ Rs 5 lakh → 100% lump sum or SLW or SUR or other approved payouts. |
| Exit due to Death | 100% lump sum permitted (remains the same). Additionally, option for availing SLW or SUR or annuity or other approved options. |
| Automatic continuation | 15-day prior intimation requirement removed across sectors. |
| Financial assistance against pension corpus | Subscriber can seek financial assistance from a regulated financial institution (lien up to 25% of own contribution). Separate Guidelines to be issued. |
| Frequency of Partial Withdrawal (PW) | i) Before 60 years of age: Frequency: 4 times; Interval: 4 years between PWs.ii) Post 60 years of age: Frequency: unlimited; Interval: 3 years between PWs (max 25% of contribution). |
| Exit rules for those who joined after 60 years of age | Conditions and limits for Tier-1 account |
| Exit | No lock-in period. Up to 80% lump sum; At least 20% annuity. |
| Exit | I) For corpus ≤ Rs 12 lakh → 100% lump sum or SLW or SUR or other approved options.II) For any corpus → Up to 80% lump sum & at least 20% annuity applies. |
| Exit due to Death | 100% lump sum permitted; (Remains same)Additionally, option for availing SLW or SUR or annuity or other approved options. |
Source: PFRDA
Tier 2 account
NPS Tier II offers greater liquidity compared with Tier I, as account holders can make partial or full withdrawals at any time without any exit load. However, the Tier II account is linked to the Tier I account and is automatically closed if the subscriber closes or exits the Tier I account.
For Central Government employees, contributions to an NPS Tier II account may qualify for a tax deduction under Section 80C, subject to a three-year lock-in period. This benefit is subject to the applicable tax provisions and conditions.
The returns or gains earned on investments in an NPS Tier II account are taxable. Such income is generally treated as income from other sources and taxed according to the subscriber’s applicable income-tax slab rate.
Which is better for you?
Tier I is the primary and mandatory NPS account, while Tier II is an optional add-on that can be activated only after opening Tier I. Tier I helps build a long-term retirement corpus and offers eligible tax benefits, whereas Tier II acts as a flexible top-up investment account with easier access to your money.
Disclaimer: This article is for informational purposes only and should not be construed as investment, financial, tax, or legal advice. Any illustrations, examples, or return projections used in this article are for explanatory purposes only and do not guarantee actual investment outcomes. The views and opinions expressed by experts quoted in this article are their own and should not be considered investment recommendations. Readers should consult a qualified professional before making any financial decisions.
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