Though I have talked about the difference between Tier 1 and Tier II NPS accounts in many of my earlier posts, I still receive a number of queries from investors asking about the difference between the two.
In fact, I had a query where the investor invested in Tier 2 NPS to avail tax benefit (figured out later).
Therefore, I think it will be useful to dedicate a post to the topic.
At a broader level, You can think of NPS Tier 2 account as an open-ended mutual fund. There are no restrictions on withdrawal from NPS Tier 2 account. However, at the same time, there are no tax benefits either for investment in Tier 2 NPS account.
So, whenever you hear about tax benefits on investing in NPS, they are referring to NPS Tier 1 account only.
Let’s look at the differences between NPS Tier 1 and Tier 2 accounts.
Difference between NPS Tier 1 and Tier 2 accounts
NPS Tier 1 vs. NPS Tier 2 account: Account opening
You can’t open NPS Tier 2 account in isolation. It has to be opened with the NPS Tier 1 account. When you close NPS Tier 1 account, Tier 2 account needs to be closed too.
Please understand both the accounts are linked to the same PRAN (Permanent Retirement Account Number). As per law, you can have only one PRAN. Both Tier 1 and Tier 2 account are linked to the same PRAM.
Read: How to open NPS account online using Aadhaar card?
NPS Tier 1 vs. NPS Tier 2 account: Minimum Contribution
As per current rules, the minimum contribution for Tier I NPS account is Rs 1,000 per financial year. There is no minimum contribution in NPS Tier 2 account.
NPS Tier 1 vs. NPS Tier 2 account: Withdrawals
Since NPS Tier 1 is a retirement account, there are many restrictions on withdrawals (before exit) from this account. You are allowed to withdraw only up to 25% of own contributions after 10 years for kids’ education and marriage, construction of house and treatment of serious illnesses.
Read: NPS Tier I: Withdrawal and Exit Rules
There are no restrictions on withdrawal in Tier 2 NPS account. You can withdraw money from the account anytime. You can even withdraw your entire investment in NPS Tier 2 account.
NPS Tier 1 vs. Tier 2 account: Mandatory Purchase of annuity on exit
At the time of exit from NPS, 40% of the accumulated corpus in NPS Tier I account has to be used towards purchase of an annuity plan. If the exit is before retirement (superannuation), 80% of the accumulated corpus in the NPS Tier 1 account has to be used to purchase an annuity plan.
There is no such restriction on NPS Tier 2 (or NPS Tier II) account. You can withdraw the entire amount lump sum.
Tier 1 vs. Tier 2 NPS account: Tax Benefit on Investment
All the tax benefits for investment in NPS are limited to investment in Tier 1 NPS account only. The benefit under Section 80CCD(1), Section 80CCD(1B) and Section 80 CCD(2) is only for investment in NPS Tier 1 account.
Read: Tax Benefit for investment for NPS Tier 1 account and Tax Treatment at maturity
There is no tax benefit for investment in Tier 2 NPS account.
NPS Tier I vs. NPS Tier II account: Tax Treatment on Maturity
For NPS Tier I account, at the time of maturity, 40% of the accumulated corpus, if withdrawn as lump sum, will be exempt from tax. At least 40% of the corpus needs to be used to purchase an annuity plan. Annuity income is taxable in the year of receipt.
Read: NPS Tier I: Tax Treatment at Maturity
For NPS Tier II, there is not much clarity about taxation at maturity. Clearly, the tax treatment of NPS Tier I has not been extended to NPS Tier II (NPS Tier 2).
There are a couple of possible options:
- The gains could be taxed as capital gains.
- The gains could simply be added to your income and taxed at your slab rate.
At the moment, I don’t know which one will apply. I have discussed this aspect in greater detail in this post.
NPS Tier 2 vs Tier I account: Transfer
You can transfer your investment from Tier 2 account to Tier 1 account (and not the other way round). Makes sense too. If the transfer from Tier I to Tier 2 were allowed, you could simply transfer your money from Tier 1 NPS to Tier 2 account and withdraw from the account. NPS Tier I would cease to be a proper retirement savings account.
Here is a recap:
PersonalFinancePlan Take
About investment in NPS Tier I, purely from the point of view of taxation, investment up to Rs 50,000 per annum may be a good choice for investors in the highest tax bracket. But yes, there are other issues around NPS Tier 1 that you need to be comfortable with before investing.
I see no reason for investing your money in Tier 2 NPS account.
31 thoughts on “What are Tier 1 and Tier 2 NPS accounts? What is the difference?”
I do invest in NPS tier 1 under all citizen model, 50k for tax saving. i feel tier 2 would be good or better than mutual funds if the taxation becomes same like as mutual funds i.e tax free after a year for equity as expense is 1/100th of a mutual fund for direct mutual fund and 1/200th on average for regular ones..what you say?
Taxation of NPS Tier II is not very clear.
Secondly, I agree NPS is a low cost product. However, they are allowed to invest in actively managed funds too. Therefore, there could be double incidence of costs.
NPS is like a balanced fund or you can say a multi-asset fund, good for conservative portfolio and backed by govt of india.
very nice analysed.
Thanks Sridhar!!!
I was in Private organization earlier and opened a Tier 1 account. Now got permanent government job. What is the procedure of transferring the NPS. My accounts office has no clue. Could you please help.
Please go through the following post.
https://www.personalfinanceplan.in/opinion/how-to-shift-nps-account/
Dear Sir,
When I have tried to open an NPS account online with a Govt. Bank I have got two options like would you like to go with Tier 1 or both Tier 1 and Tier 2? If I choose both Tier 1 and Tier 2 then what is the benefit? Please help me to understand it clearly.
Thanks.
Dear Biswanath,
Go with only Tier-I account.
sir please tell why should any one invest in tier 1 as they get their money after 60 years of age but in tier 2 they can withdraw anytime they want their money.
Tier 2 is no special product. It is just like mutual funds.
There is no tax benefit for investment in NPS Tier 2 account.
Well written article. Thank you.
If I select both tier 1 and tier 2 options and SBI PF for tier 1 and HDFC PF for tier ii which option they will select, as I am a government employee in tier I I can’t select hdfc
Guess they will have to ask you to fill the form again.
sir, I started my career in a private company in 2016 and till now working with the same company. But I don’t have any idea about this NPS. Please tell me to whether Should I register in NPS or not. If yes then what will be the benefit of it in future.
Thanks & regards
Hi Kundan,
There are many posts on this website about NPS. Please go through those.
You will have to make a decision on your own.
Hi Sir,
I am Working in a private organization which offers low salary, currently my age is 29, although my company has EPS and EPF, but can you please tell me weather I can open NPS account separately with any bank or not?
and also after getting the PRAN no, can I use the same PRAN no for Atal Pension Yojana, since it is asking for PRAN details in APY while filling the form.
You can open NPS. you can open APY too. However, you can have just 1 PRAN.
NSDL has told that one can open both NPS and APY.
I am not sure how this PRAN thing works internally.
I checked APY form online. There was no way to enter PRAN over there.
Can you please share the form?
If the amount will be deducted automatically from bank account linked or have to deposit manually. And if the monthly contribution can be changed. Please guide.
Mostly manually. Monthly allocation can be changed.
Some sites may allow automated investments.
Which fund manager is performing best under Tier I? Can we change the Fund Manager under the same tier?
You can change the fund manager.
Got a clear picture. Thank you. The best article on this topic.
Thanks Dr. Lakshmi.
Just one thing, from FY20, the investments in Tier2 account will be eligible for tax benefits under Section 80C (1.5 lacs) provided the money is kept locked in for 3 years. This is a recent change. Even with this change, I am not too fond of Tier 2 NPS.
I Just activate tier 2. should I submit the downloaded form in my home branch
I received a PRAN in 2014 which is not transacted even once till date for NPS-Lite.. I want to invest in NPS now. Need I have to use the existing PRAN or have to register for new one?
I am a freelancer, I am 32 years old. This is true that freelancer’s income not fix, so Tier I account I don’t think this is good for us, we can’t withdraw full invested money during locking period for emergency case, So Tier 2 account is good, now also it is tax free I just saw (Deepesh Raghaw) a new comment. I might be wrong. Anyway I like your article Deepesh Raghaw sir. Thanks for sharing.
Thanks Maria.
Yes, I understand money gets locked in NPS. So, someone without a consistent income will have issues.
Please understand Tier 2 is not tax-free. From FY2019, only the investment in Tier 2 may get tax benefit under Section 80C. Redemptions are not exempt from tax.
I am a basic teacher in uttar pradesh.
Which account is good for me.
Can i open it online without filling up the offline subscriber registration form?
I am a basic teacher in uttar pradesh.
Which NPS account is good for me?
Can i open it online without filling up the offline subscriber registration form?
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