In 2004, the Authorities of India launched the Nationwide Pension System (NPS) as a long-term financial savings scheme designed to offer people with monetary safety after they retire. Initially, solely authorities workers had been allowed to take part on this scheme, however in 2009, it was opened as much as all Indian residents between the age of 18 and 70.
This implies any particular person in that age bracket, whether or not NRI, self-employed, or working within the non-public sector can put money into NPS. You might have heard folks discuss in regards to the tax-saving and wealth-building advantages of NPS. However do you know that more often than not, they’re really referring to the NPS Tier 1 account? Sure! NPS isn’t only one account – it has two sorts: Tier 1 and Tier 2, and every serves a distinct objective.
For a lot of, NPS acts as a useful tax and funding planning automobile, and for good motive. Let’s perceive why that’s as we reply what’s tier 1 and tier 2 in NPS and talk about which one is perhaps the appropriate alternative for tax planning by wanting on the distinction between tier 1 and tier 2 NPS accounts.
What’s NPS Tier 1 and Tier 2?
Earlier than we examine the 2 accounts, we’ve received to know the construction of NPS and the way it works as a retirement financial savings scheme. Regulated by the Pension Fund Regulatory and Improvement Authority (PFRDA), the NPS permits traders to contribute in direction of their retirement financial savings whereas benefiting from skilled fund administration.
As this organisation is established underneath the Indian Trusts Act, it ensures that the NPS operates with transparency and accountability, and thus it prioritises defending the traders’ pursuits.
NPS permits people to put money into professionally managed funds consisting of 4 asset lessons:
- Fairness (E): This refers back to the investments made within the share markets. These devices present larger returns with average to excessive danger.
- Authorities Securities (G): Consists of quick and long-term authorities bonds, state bonds, and different government-backed devices which give security but in addition decrease returns.
- Company Bonds (C): These are additionally fixed-income devices, however they provide barely larger returns than authorities securities by investing in high-rated company debt.
- Various Belongings (A): A small portion of investments will be invested in various funding funds, actual property funding trusts (REITs), and different various investments to diversify the portfolio.
There are two methods in which you’ll allocate your investments in NPS:
Lively Selection:
This feature lets you manually choose the proportion of your contributions throughout the 4 asset lessons, i.e., Fairness (E), Company Bonds (C), Authorities Securities (G), and Various Belongings (A). By deciding on this feature you’ll achieve the flexibleness to construct your portfolio based mostly in your danger tolerance and monetary objectives. Nevertheless, you have to be conscious of some allocation limits.
For instance, people aged as much as 50 years can solely allocate a most of 75% of their funds to equities. Upon reaching 60, this restrict decreases to 50%. For those who go for energetic alternative, you’ll be allowed to alter the asset allocation twice a 12 months. You may modify your portfolio based mostly on market situations, danger tolerance, monetary objectives, and circumstances.
Auto Selection:
Because the title suggests, on this possibility the allocation is finished routinely. This allocation is predicated on the investor’s age. Because the investor grows outdated, the publicity to equities slowly decreases and extra funds are shifted into low-risk property like authorities securities. For those who don’t need the effort of adjusting asset allocation once in a while, you possibly can go for this auto-choice possibility. Right here, traders have three choices to select from:
- Aggressive life cycle fund, which begins with 75% fairness publicity for youthful traders and slowly decreases with time. It is because youthful people can usually tackle extra danger as they’ve the time to get well from market fluctuations.
- Average life cycle fund, which begins with 50% fairness publicity.
- Conservative life cycle fund, which begins with 25% fairness publicity.
Now let’s perceive what NPS tier 1 and tier 2 accounts are.
NPS Tier 1 Account
The NPS tier 1 account is obligatory. When one begins investing in NPS, that is the default account that they have to open to take part within the scheme. To open a Tier 1 account, an investor should make a minimal contribution of Rs. 500 on the time of account opening. After that, one can contribute as a lot as they need. Not like the Provident Fund, there isn’t a most funding restrict in NPS. You need to, nevertheless, make a minimal contribution of Rs. 1,000 yearly to your Tier 1 account.
For the reason that primary objective of this account is to assist people construct a retirement corpus, it will possibly solely be withdrawn after the investor turns 60. Even then, traders can solely withdraw 60% of their funds and should use the remaining 40% to purchase an annuity plan, which gives them with a daily pension after retirement.
Nevertheless, if in case you have accomplished a minimum of 3 years within the NPS, you possibly can partially withdraw funds underneath particular circumstances, like financing your youngsters’s larger training, establishing a home, or masking medical emergencies. You may solely withdraw 25% of your contribution quantity and solely as much as thrice throughout your NPS tenure.
Observe that you would be able to solely withdraw 25% of your contribution quantity, so when you invested Rs. 5 lakh over three years and your funding grew to Rs. 8 lakh, you’ll nonetheless solely be eligible to withdraw 25% of your unique contribution quantity, which is Rs. 1.25 lakh (25% of Rs. 5 lakh), and never 25% of Rs. 8 lakh.
These accounts additionally provide very enticing tax deductions underneath Sections 80C, 80CCD(1B), and 80CCD(2) of the Revenue Tax Act, making it probably the most tax-efficient funding choices out there.
NPS Tier 2 Account
Transferring on to what’s tier 2 in NPS. That is an optionally available account that gives totally different advantages in comparison with the Tier 1 account. The NPS tier ii account will be opened with a minimal funding of Rs. 250 and provided that you have already got an energetic Tier 1 account. We noticed that Tier 1 is extra targeted on retirement planning. The NPS tier 2 then again is extra targeted on funding planning because it gives traders a lot larger liquidity and adaptability. You may withdraw funds from this account anytime as there isn’t a lock-in interval concerned, and even allocate 100% of your funds to equities underneath the energetic alternative possibility.
Whereas the Tier 2 account is enticing from an funding perspective, it doesn’t present the tax advantages that Tier 1 does. Furthermore, no investments in various property are allowed in Tier 2, and funds can solely be allotted to fairness (E), company bonds (C), and authorities securities (G).
NPS Tier 1 vs Tier 2: Key Variations
Now that you’re in control with what’s tier 1 and tier 2 in NPS, take a look at how these accounts differ:
| Issue | NPS Tier 1 Account | NPS Tier 2 Account |
| Objective | Tier 1 is a pension account designed for retirement planning. | Tier 2 accounts are geared extra in direction of funding planning. |
| Minimal Funding | At the least Rs. 500 should be invested when opening a Tier 1 account, after which a minimal annual contribution of Rs. 1,000 is critical. | A minimal funding of Rs. 250 is required for opening a Tier 2 account with no minimal annual contribution required. |
| Eligibility | Indian residents aged between 18 and 70 can open an NPS Tier 1 account. | Solely people with an energetic Tier 1 account can open a Tier 2 account. |
| Sort of Account | This can be a obligatory account for investing in NPS. | The Tier 2 account is optionally available. |
| Lock-in Interval | Funds in Tier 1 accounts are locked in until the traders attain the age of 60. | No lock-in period in these accounts. |
| Withdrawals | 60% of the gathered funds will be withdrawn after the investor reaches 60, whereas the remaining is used to purchase an annuity plan. Untimely withdrawals (restricted to 25% of the contribution quantity) are allowed underneath particular situations after an preliminary lock-in of three years. | Tier 2 accounts haven’t any restrictions on withdrawals. |
| Asset Lessons | Tier 1 accounts provide 4 asset lessons: fairness (E), company bonds (C), authorities securities (G), and various property (A). | Solely three asset lessons are provided in Tier 2 accounts, one can not put money into various property (A). |
| Lively Selection Possibility | You may select to allocate a most of 75% of your funds to equities within the Tier 1 account. | You may allocate the whole lot of your funds to equities if you want. |
| Tax Advantages | Tier 1 accounts provide important tax benefits underneath Sections 80C and 80CCD(1B). They’re additionally EEE investments, making them probably the most tax-efficient automobiles out there. | Tier 2 accounts provide very restricted tax benefits. |
The primary distinction between NPS tier 1 vs tier 2 accounts is their objective. For the reason that major purpose of NPS is to assist folks plan for his or her post-retirement revenue, the extra fashionable Tier 1 account is designed with strict withdrawal guidelines, obligatory annuities, and wonderful tax advantages. Tier 2 is an optionally available funding account that gives higher liquidity however restricted tax advantages. An funding planner can assess your monetary profile and make it easier to decide whether or not the optionally available account can be appropriate for you.
Tax Advantages of NPS Tier 1
NPS holds the uncommon standing of having fun with the EEE (Exempt Exempt Exempt) tax profit, a privilege shared by only some funding choices just like the Public Provident Fund and Sukanya Samriddhi Yojana.
- The primary tax exemption is within the contribution stage. There’s no tax on the principal quantity and contributions to NPS tier 1 take pleasure in deductions underneath Sections 80C and 80CCD(1B). Mixed, these sections enable traders to say deductions as much as Rs. 2 lakh per 12 months, however solely underneath the outdated tax regime.
- The second exemption is within the accrual stage. As your funding grows, it’ll appeal to no tax on returns generated throughout the NPS Tier 1 account.
- And lastly, the third exemption is within the maturity stage. 60% of the corpus will be withdrawn tax-free, whereas the remaining 40% should be used to purchase an annuity. The common revenue from annuity plans is taxable as per the investor’s revenue slab fee. Even untimely withdrawals appeal to no tax.
Right here’s a extra detailed take a look at the NPS tier 1 tax profit:
Deductions underneath Part 80C
Each monetary 12 months, you possibly can declare a most deduction of as much as Rs. 1.5 lakh on contributions made in direction of Part 80C investments like PPF, EPF, ELSS, ULIP, and NPS.
Deductions underneath Part 80CCD(1B)
This part is an extension of 80C, which permits traders to say an extra deduction of Rs. 50,000 on contributions made in direction of NPS. This takes the entire tax good thing about NPS to Rs. 2 lakh! Keep in mind that 80C and 80CCD(1B) advantages are solely out there to traders submitting their ITR underneath the outdated tax regime.
Deductions underneath Part 80CCD(2)
In case you are a salaried particular person and your employer contributes to your NPS Tier 1 account, you possibly can declare a tax deduction over and above the Rs. 1.5 lakh restrict underneath Part 80C and the extra Rs. 50,000 underneath Part 80CCD(1B). You may declare as much as 10% of your fundamental wage + dearness allowance as a deduction. This profit is among the uncommon tax deductions out there even underneath the brand new tax regime. It’s best to take into account consulting an funding knowledgeable when you want to make the most of these advantages.
Tax Advantages and Drawbacks of NPS Tier 2
The NPS tier 2 tax profit is restricted in comparison with Tier 1. Contributions to tier 2 NPS accounts don’t qualify for tax deductions underneath the sections we mentioned above. The account lacks the EEE tax standing as withdrawals are totally taxable as per your revenue slab. For those who’re excited about investing by means of the NPS tier 2 account for the mid to short-term, a gathering with a monetary guide is perhaps useful. Despite the fact that it doesn’t present tax benefits, the Tier 2 account’s versatile withdrawal guidelines will be enticing for some traders.
Which Possibility is Higher for Your Tax Planning?
So far as tax planning goes, there’s little doubt which between tier 1 and tier 2 NPS accounts can be the higher decide. With a number of tax advantages underneath Sections 80C, 80CCD(1B), and 80CCD(2), Tier 1 is the superior alternative. This account helps traders cut back taxable revenue whereas constructing a retirement corpus. However, NPS tier 2 gives no main tax benefits.
Despite the fact that it gives larger liquidity and potential for development resulting from limitless fairness allocation, it lacks the EEE tax standing and makes withdrawals totally taxable. If you wish to save extra of your hard-earned cash, give our knowledgeable tax advisory providers a attempt. Our advisors may also help you construction your investments by means of personalised planning, ensuring you maximise tax advantages whereas aligning them together with your long-term monetary objectives.
Conclusion
The NPS tier 1 and tier 2 accounts differ primarily of their objective, tax advantages, and withdrawal guidelines. The Tier 1 account is designed for retirement financial savings and gives many advantages underneath the Revenue Tax Act. For the reason that Tier 2 account focuses primarily on investments, it gives excessive liquidity however lacks any notable tax benefits.