National Pension Scheme: All you need to know

NPS Tier1 and 2
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National Pension Scheme or NPS is one of the best retirement plans sponsored and supported by the government of India. The scheme was launched back in January 2004 to provide a retirement plan to government employees. It was later opened for everyone in 2009. NPS allows individuals to contribute regularly to a pension account throughout his/her working life. The investor can later withdraw a lump sum part of the corpus and use the remaining amount to buy an annuity in order to secure regular income post retirement.

NPS Tier 1 vs Tier 2

When it comes to investing in NPS, people often get confused between the options available. There are two types of accounts available in NPS- NPS Tier 1 and Tier 2.

  • NPS Tier 1- Meant for retirement savings for government and private sector employees and other Indian citizens.
  • NPS Tier 2- Meant for additional contribution to the existing NPS account.

To understand what is Tier 1 and Tier 2 in NPS, we need to learn the differences between the two. 

As said, NPS offers two types of accounts for investors as of now:

NPS Tier 1 Account

It is a retirement savings account for government employees, private sector employees, and other Indian citizens as well. You can open this account with a minimum investment of Rs 500. Post retirement, you can withdraw up to 60% of the corpus and use the remaining 40% to purchase an annuity that can secure you a regular source of income.

Upon opening an NPS Tier 1 account, you will get a Permanent Retirement Account Number (PRAN). The investments made in this account are locked-in until you reach 60 years of age, i.e; the age of retirement. However, there is an option to make partial withdrawals and premature exit from the plan. NPS Tier 1 account also allows you to enjoy tax deduction benefits for the contributions made.

Features and Conditions of NPS Tier 1 Account

  • Any Indian citizen between the age of 18 and 60 can apply for an NPS Tier 1 account.
  • The minimum contribution that can be made in NPS Tier 1 account is Rs 500 and at least Rs 6,000 per year. However, there is no upper cap on investment.
  • NPS Tier 1 Account is mandatory for government employees. Although it is not mandatory, private sector employees and self-employed individuals can also open an NPS account.
  • Funds from NPS Tier 1 Account can be withdrawn in either of the three cases- Retirement from job/service, resignation, or in case of death. 
  • Upon maturity, you can withdraw a lump sum amount of the corpus and use the rest to buy an annuity.
  • In case of resignation before 60 years, you can only withdraw 20% of corpus in lump sum. The remaining amount should be used to purchase an annuity.
  • You can also make premature withdrawal before maturity or withdraw partially before resignation only with the condition that you have remained invested for at least 10 years. You are allowed to withdraw 25% of the contributions made by self in the corpus for specific reasons such as financing higher education or funding marriage of any of your children, for buying the first house property, for treatment of a life-threatening disease.

Withdrawal From NPS Tier 1 Account

  • Post retirement, you can either remain invested or withdraw. In case you opt for withdrawal, you can withdraw up to 60% of the corpus and use the remaining 40% to buy an annuity for regular income.
  • In case you opt for premature withdrawal or pre retirement withdrawal, you can only withdraw 20% of the corpus and use the remaining amount to buy an annuity.

Investment Options Available Under NPS Tier 1

NPS Tier 1 allows you to invest in a mix of equity instruments, corporate and government debt instruments, and alternate assets like gold estate. However, the equity allocation is limited to 75% of the total asset allocation. Whereas, the alternate asset allocation is limited to only 5%.

You are also given the option to choose either from one of the automated lifecycle-based portfolios or customize the allocation of assets. If you choose to manually customize the asset allocation, the preferences will remain the same only until 50 years of age. After 50 years, the equity allocation will come down to 50% of the total asset allocation by the time you reach 60 years of age.

Instead, you can go for automatic portfolio management, in which you are given three options- 

  • LC30 - Up to 30% equity allocation until 35 years of age.
  • LC50 - Up to 50% equity allocation until 35 years of age.
  • LC75 - Up to 75% equity allocation until 35 years of age.

In all cases, the equity allocation continues to decline and the government debt allocation continues to increase after 35 years to make the portfolio less risky.

Taxation Benefits in NPS Tier 1 Account

With NPS Tier 1 Account, you can save taxes both at the time of making investments and during maturity. 

You can claim tax exemptions of up to Rs 2 lakh for the contributions made in NPS. Now since we know that the NPS account can get contributions both from the employer and the account holder, the taxation benefits are also different for the source of contribution.

  • For Employer’s Contribution: Private sector employees can claim tax deductions of up to 10% of their Basic + DA (Dearness Allowance) salary. On the other hand, the limit for government employees is up to 14% of Basic + DA salary.
  • For Self-Contribution: Provisions laid under section 80CCD (1) of the Income Tax Act allows tax exemptions of up to Rs 1.5 lakh. However, contributions exceeding 10% of Basic + DA salary are not eligible for exemptions. Besides, in case the 10% of the Basic + DA salary is over 1.5 lakh, or in case of additional investment, the NPS account holder can claim additional tax exemption of up to Rs 50,000 through the provisions laid under section 80CCD (1B).

NPS Tier 1 Performance

Best Performing NPSs – Central Government Scheme as of May 31, 2021

Funds6-month return (%)3-year return (%)5-year return (%)
SBI Pension Fund3.54%11.29%9.93%
UTI Retirement Solutions4.27%11.29%10.07%
LIC Pension Fund4.40%11.28%9.93%

Best Performing Tier 1 NPSs – Scheme E as of May 31, 2021

Funds6-month return (%)3-year return (%)5-year return (%)
HDFC Pension Fund21.35%14.02%15.36%
UTI Retirement Solutions21.97%12.79%14.04%
SBI Pension Fund19.78%12.30%13.54%

NPS Tier 2 Account

It is an open-access account and is meant for those who want to make additional contributions to their NPS account. Unlike NPS Tier 1, Tier 2 does not come with any lock-in period. 

Features and Conditions of NPS Tier 2 Account

  • The minimum amount that can be invested in NPS Tier 2 Account is Rs 1,000. However, you need to contribute at least Rs 250 every year and have to maintain a minimum of Rs 2,000 at the end of a financial year.
  • There is no lock-in period in NPS Tier 2 Account.
  • No limit on investment and withdrawal.

Withdrawal From NPS Tier 2 Account

There is no limit on withdrawals that the NPS Tier 2 account holder can make.

Taxation Under NPS Tier 2 Account

Unlike NPS Tier 1, there are no exemptions allowed for the contributions made in NPS Tier 2 Account. Also, the gains made from withdrawals are considered as capital gains and are taxed as per the taxpayer’s tax slab rate.

NPS Tier 2 Performance

Best Performing Tier 2 NPSs – Scheme E as of May 31, 2021

Funds6-month return (%)3-year return (%)5-year return (%)
HDFC Pension Fund21.23%13.93%15.41%
UTI Retirement Solutions23.07%13.36%14.35%
SBI Pension Fund19.75%12.41%13.61%

NPS Tier 1 and Tier 2: Differences 

Here is a summary of the differences between Tier 1 and Tier 2 NPS

BasisNPS Tier 1NPS Tier 2
Minimum InvestmentRs 500 and at least Rs 6,000 annuallyRs 1,000 and Rs 250 every year. Also, Rs 2,000 to be maintained at the end of a financial year
Maximum InvestmentNo limitNo limit
EligibilityAnyone between 18 to 60 years of ageAnyone between 18 to 60 years of age and having NPS Tier 1 Account
Mandatory for:Mandatory for government employees. Private sector employees and self-employed individuals can also opt for thisNot mandatory for anyone
Limit on Withdrawal

60% after retirement

20% in case resignation is given before retirement

25% of the self-contribution in case of premature exit (only for specific conditions)

No limit on withdrawal
Tax Benefits Tax exemptions of up to Rs 2 lakhs under section 80CCD (1) and 80CCD (1B)No tax benefits

So we have a comprehensive knowledge of NPS Tier 1 and NPS Tier 2 Schemes. It is important to note that investments made under NPS Tier 2 Account are also likely to become eligible for taxation benefits under section 80C. However, the same is yet to be announced and made formal by the government. Overall, it can be concluded that both NPS Tier 1 and Tier 2 are one of the best retirement savings schemes that one can opt for.

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