NPS Tier 1 vs Tier 2: Differences, Benefits, Tax Savings, & Account Types Explained

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People love the thought of planning; maybe because they like to be prepared for everything. But when it comes to financial planning, nothing is more critical than planning for our retirement, especially for those of us who work regular jobs. Once you retire, those monthly paychecks stop coming in, but the bills certainly don't. It can be quite challenging to make ends meet if you haven't prepared for your retirement.

One smart move is to consider investing in various savings schemes specifically designed for retirement. And one of the most beneficial schemes on the block is the National Pension System (NPS), introduced by the government. Let’s break down what NPS Tier 1 and Tier 2 are, how they differ, the tax benefits they offer, and more. So, let's dive into the world of retirement planning with NPS!

NPS: A brief overview

Back in 2004, the government introduced the National Pension System (NPS) as a pension program. At first, it was exclusively for government employees, but in 2009, the government made it accessible to everyone. What's great about NPS is that individuals can start contributing to their NPS accounts while they're still employed and withdraw the funds once they hit the age of 60.

In simpler terms, think of NPS as a sort of annuity product that serves as your financial safety net in retirement.

Now, within NPS, there are two distinct types of account: Tier 1 and Tier 2 NPS accounts.

Tier 1 is your primary NPS account, primarily aimed at building a robust retirement fund.

Tier 2 is more like a flexible savings account, allowing you greater freedom in making deposits and withdrawals.

Let's learn about NPS scheme details along with Tier 2

NPS Tier 1 & NPS Tier 2: Overview

Let’s understand the National Pension Scheme Tier 1 and Tier 2 more.

NPS Tier 1

NPS Tier 1 scheme serves as your primary retirement account and comes with a mandatory lock-in period until you reach the age of 60. This account is open to all Indian citizens, be it public or private sector employees, self-employed individuals, or OCI or NRIs. The contributions you make to this account offer tax benefits under Section 80C of the Income Tax Act, with a maximum deduction of Rs. 1.5 lakh per year, along with an additional deduction of up to Rs. 50,000 under Section 80CCD (1B).

This tax benefit applies to both premature withdrawals and the purchase of annuities. Furthermore, Tier 1 accounts have more restrictions when it comes to early withdrawals, making it more challenging to access your funds before maturity.

NPS Tier 2

Tier 2 NPS is an optional investment account available to all NPS subscribers, including those who already hold a Tier 1 account. Unlike Tier 1 NPS, there's no lock-in period in Tier 2, allowing you to withdraw your savings whenever you need them, without any restrictions. However, it's important to note that the contributions made to this account do not qualify for tax benefits under Section 80C of the Income Tax Act. This account can ideally serve as a secondary investment option for non-retirement financial goals.

Tax Benefits On NPS Tier 1 And Tier 2 Returns

When it comes to investing in NPS Tier 1 and Tier 2, it's important to be aware of the tax benefits:

Employee’s Contribution: Employees can enjoy tax deductions under section 80CCD (1) of the Income Tax Act for their contributions, with a limit of up to 10% of their salary, which includes Basic and DA. This falls within the overall ceiling of Rs. 1.50 lakh specified under section 80CCE.
Employer’s Contribution: Employers can contribute up to 10% of Basic and DA without any monetary limit and claim deductions under section 80CCD (2). This benefit is in addition to the Rs. 1.50 lakh limit under section 80CCE.
Voluntary Contribution: Employees have the option to make voluntary contributions of Rs. 50,000 or more to their NPS Tier I account. They can claim tax deductions on these contributions under section 80CCD 1(B), subject to a maximum of Rs. 50,000.

By keeping these aspects in mind and including them in your income tax return (ITR) filing, you can claim significant tax savings. However, it's important to remember that these perks are applicable only to owners of Tier 1 NPS accounts.

NPS Tier 1 vs Tier 2 – Which One Should You Choose?

When deciding between NPS Tier 1 and Tier 2, it's essential to consider your financial goals and investment preferences. NPS Tier 1 is primarily designed for retirement savings and comes with certain restrictions like a lock-in period and minimum annual contributions. It is suitable for individuals looking for a long-term retirement savings solution.

On the other hand, NPS Tier 2 offers more flexibility as it allows you to withdraw your investments at any time, making it a more liquid option. However, Tier 2 doesn't offer the same tax benefits as Tier 1. If you are seeking an investment avenue for short-term financial goals or as an emergency fund, Tier 2 might be more appropriate. Ultimately, the choice between NPS Tier 1 and Tier 2 depends on your specific financial objectives, risk tolerance, and the level of access and control you desire over your investments.

Claiming Tax Benefits on tier 1 and tier 2 NPS Returns

Tax Deductions Under Section 80CCD (1): For all NPS Tier 1 subscribers, there's the opportunity to claim tax deductions of up to ₹1.5 lakhs under Section 80CCD (1).
Additional Deduction Under Section 80CCD (1B): Tier 1 investors can also benefit from an extra deduction of up to ₹50,000. It's important to note that this deduction is in addition to the ₹1.5 lakh deduction under Section 80CCD (1).
Partial Withdrawals: In situations where you make partial withdrawals, a significant 25% of the withdrawn amount enjoys an exemption from taxes. This option is available thrice in entire lifetime to holding NPS PRAN.
Tax-Free Annuity Investments: Opting for an annuity comes with a unique perk – the entire invested amount remains tax-free. However, it's important to remember that the income generated from the annuity is subject to taxation at the prevailing rates.
Lump Sum Withdrawals After 70: Post this age, opting for a lump sum withdrawal, you can avail tax exemptions on up to 60% of the withdrawn amount. The remaining portion (which is mandatory 40%) is utilised to purchase an annuity, and the returns from this annuity are taxable.
Tax Benefits for Employers: Under Section 80CCD(2), an employer can contribute up to 10% of an employee's Basic + D.A. towards their NPS account, with a cap of ₹7,50,000. This total encompasses contributions made to NPS, PF, and Superannuation all by employer only

Ways to Opening NPS Account with Kotak

Investing in NPS via Kotak's "myNPS" portal is a convenient and paperless process. Here's a breakdown of the steps and documents needed for each registration method:

Aadhaar eKYC: Link Aadhaar, upload mobile, email, photo, signature, Cancelled Cheque, and make a ₹500 payment.
PAN-based Registration: Link PAN, upload mobile, email, photo, signature, Cancelled Cheque, and make a ₹500 payment.
Driving Licence Registration: Authenticate via Digilocker, upload Driving License, PAN, mobile, email, photo, signature, Cancelled Cheque, and make a ₹500 payment.
Aadhaar via Digilocker: Authenticate via Digilocker, upload Aadhaar, PAN, mobile, email, photo, signature, Cancelled Cheque, and make a ₹500 payment.
KYC Verification by POP: Verify via empanelled POP, link existing active account, upload mobile, email, photo, and make a ₹500 payment. There is additional charge of Rs. 125 to be appended for the KYC verification completed by the PoP.

Each method ensures a swift, paperless process for NPS account creation. Simply select the one that suits your preferences and get started with Kotak's "myNPS" portal.

FAQs

Q1 : What is NPS Tier 1?

NPS Tier 1 is the primary retirement account with a lock-in period, offering tax benefits and geared towards long-term savings.

Q2 : What is e-NPS?

e-NPS is the digital platform for managing your National Pension System (NPS) account online.

Q3 :How can I open an e-NPS account?

To open an e-NPS account, visit the official NPS website and follow the online registration process.

Q4 : Do NPS Tier 2 investments offer tax benefits?

No, NPS Tier 2 investments do not provide tax benefits beyond regular income tax rules.

Q5 : What is tier 1 and tier 2 in nps

Tier 1 is the primary NPS account for retirement savings, while Tier 2 offers more flexibility for withdrawals but lacks tax benefits.

NPS Tier 1 Vs Tier 2 Account: Differences and Tax Benefits