In 2004, the Authorities of India launched the Nationwide Pension System (NPS) as a long-term financial savings scheme designed to supply 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 spend money on NPS. You’ll have heard individuals speak concerning 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 varieties: Tier 1 and Tier 2, and every serves a unique function.
For a lot of, NPS acts as a invaluable tax and funding planning automobile, and for good purpose. 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 best alternative for tax planning by trying on the distinction between tier 1 and tier 2 NPS accounts.
What’s NPS Tier 1 and Tier 2?
Earlier than we evaluate the 2 accounts, we’ve bought to grasp the construction of NPS and the way it works as a retirement financial savings scheme. Regulated by the Pension Fund Regulatory and Growth Authority (PFRDA), the NPS permits buyers to contribute in direction of their retirement financial savings whereas benefiting from skilled fund administration.
As this organisation is established beneath the Indian Trusts Act, it ensures that the NPS operates with transparency and accountability, and thus it prioritises defending the buyers’ pursuits.
NPS permits people to spend money on professionally managed funds consisting of 4 asset lessons:
- Fairness (E): This refers back to the investments made within the share markets. These devices present increased returns with reasonable to excessive threat.
- Authorities Securities (G): Consists of quick and long-term authorities bonds, state bonds, and different government-backed devices which offer security but additionally decrease returns.
- Company Bonds (C): These are additionally fixed-income devices, however they provide barely increased returns than authorities securities by investing in high-rated company debt.
- Different Belongings (A): A small portion of investments may be invested in different funding funds, actual property funding trusts (REITs), and different different investments to diversify the portfolio.
There are two methods in which you’ll be able to allocate your investments in NPS:
Lively Selection:
This feature permits you to manually choose the proportion of your contributions throughout the 4 asset lessons, i.e., Fairness (E), Company Bonds (C), Authorities Securities (G), and Different Belongings (A). By deciding on this feature you’ll achieve the pliability to construct your portfolio primarily based in your threat tolerance and monetary objectives. Nonetheless, you ought 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%. If you happen to go for lively alternative, you’ll be allowed to alter the asset allocation twice a yr. You possibly can modify your portfolio primarily based on market circumstances, threat tolerance, monetary objectives, and circumstances.
Auto Selection:
Because the title suggests, on this possibility the allocation is finished mechanically. This allocation relies on the investor’s age. Because the investor grows previous, the publicity to equities slowly decreases and extra funds are shifted into low-risk property like authorities securities. If you happen to don’t need the trouble of fixing asset allocation infrequently, you’ll be able to go for this auto-choice possibility. Right here, buyers have three picks to select from:
- Aggressive life cycle fund, which begins with 75% fairness publicity for youthful buyers and slowly decreases with time. It is because youthful people can sometimes tackle extra threat as they’ve the time to get better from market fluctuations.
- Reasonable 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 need 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 want. In contrast to the Provident Fund, there isn’t a most funding restrict in NPS. You could, nonetheless, make a minimal contribution of Rs. 1,000 yearly to your Tier 1 account.
Because the primary function of this account is to assist people construct a retirement corpus, it will probably solely be withdrawn after the investor turns 60. Even then, buyers can solely withdraw 60% of their funds and should use the remaining 40% to purchase an annuity plan, which supplies them with a daily pension after retirement.
Nonetheless, when you have accomplished at the very least 3 years within the NPS, you’ll be able to partially withdraw funds beneath particular circumstances, like financing your kids’s increased training, developing a home, or protecting medical emergencies. You possibly can solely withdraw 25% of your contribution quantity and solely as much as thrice throughout your NPS tenure.
Observe that you could 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’d 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 supply very engaging tax deductions beneath Sections 80C, 80CCD(1B), and 80CCD(2) of the Revenue Tax Act, making it one of the vital tax-efficient funding choices out there.
NPS Tier 2 Account
Transferring on to what’s tier 2 in NPS. That is an non-obligatory account that gives totally different advantages in comparison with the Tier 1 account. The NPS tier ii account may be opened with a minimal funding of Rs. 250 and provided that you have already got an lively Tier 1 account. We noticed that Tier 1 is extra centered on retirement planning. The NPS tier 2 then again is extra centered on funding planning because it gives buyers a lot increased liquidity and suppleness. You possibly can withdraw funds from this account anytime as there isn’t a lock-in interval concerned, and even allocate 100% of your funds to equities beneath the lively alternative possibility.
Whereas the Tier 2 account is engaging from an funding perspective, it doesn’t present the tax advantages that Tier 1 does. Furthermore, no investments in different 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 on top of things with what’s tier 1 and tier 2 in NPS, try how these accounts differ:
| Issue | NPS Tier 1 Account | NPS Tier 2 Account |
| Function | 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 have to be invested when opening a Tier 1 account, after which a minimal annual contribution of Rs. 1,000 is important. | 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 lively Tier 1 account can open a Tier 2 account. |
| Kind of Account | This can be a obligatory account for investing in NPS. | The Tier 2 account is non-obligatory. |
| Lock-in Interval | Funds in Tier 1 accounts are locked in until the buyers attain the age of 60. | No lock-in period in these accounts. |
| Withdrawals | 60% of the collected funds may be withdrawn after the investor reaches 60, whereas the remainder is used to purchase an annuity plan. Untimely withdrawals (restricted to 25% of the contribution quantity) are allowed beneath particular circumstances after an preliminary lock-in of three years. | Tier 2 accounts don’t have any restrictions on withdrawals. |
| Asset Lessons | Tier 1 accounts supply 4 asset lessons: fairness (E), company bonds (C), authorities securities (G), and different property (A). | Solely three asset lessons are supplied in Tier 2 accounts, one can not spend money on different property (A). |
| Lively Selection Choice | You possibly can select to allocate a most of 75% of your funds to equities within the Tier 1 account. | You possibly can allocate the whole thing of your funds to equities if you want. |
| Tax Advantages | Tier 1 accounts supply vital tax benefits beneath Sections 80C and 80CCD(1B). They’re additionally EEE investments, making them one of the vital tax-efficient automobiles out there. | Tier 2 accounts supply very restricted tax benefits. |
The principle distinction between NPS tier 1 vs tier 2 accounts is their function. Because the major objective of NPS is to assist individuals plan for his or her post-retirement earnings, the extra well-liked Tier 1 account is designed with strict withdrawal guidelines, obligatory annuities, and wonderful tax advantages. Tier 2 is an non-obligatory funding account that gives higher liquidity however restricted tax advantages. An funding planner can assess your monetary profile and enable you to decide whether or not the non-obligatory account could 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 just a few 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 beneath Sections 80C and 80CCD(1B). Mixed, these sections permit buyers to say deductions as much as Rs. 2 lakh per yr, however solely beneath the previous tax regime.
- The second exemption is within the accrual stage. As your funding grows, it’s going to entice no tax on returns generated inside the NPS Tier 1 account.
- And lastly, the third exemption is within the maturity stage. 60% of the corpus may be withdrawn tax-free, whereas the remaining 40% have to be used to purchase an annuity. The common earnings from annuity plans is taxable as per the investor’s earnings slab fee. Even untimely withdrawals entice no tax.
Right here’s a extra detailed take a look at the NPS tier 1 tax profit:
Deductions beneath Part 80C
Each monetary yr, you’ll be able to 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 beneath Part 80CCD(1B)
This part is an extension of 80C, which permits buyers to say a further deduction of Rs. 50,000 on contributions made in direction of NPS. This takes the full tax advantage of NPS to Rs. 2 lakh! Do not forget that 80C and 80CCD(1B) advantages are solely out there to buyers submitting their ITR beneath the previous tax regime.
Deductions beneath Part 80CCD(2)
In case you are a salaried particular person and your employer contributes to your NPS Tier 1 account, you’ll be able to declare a tax deduction over and above the Rs. 1.5 lakh restrict beneath Part 80C and the extra Rs. 50,000 beneath Part 80CCD(1B). You possibly can declare as much as 10% of your primary wage + dearness allowance as a deduction. This profit is among the uncommon tax deductions out there even beneath the brand new tax regime. It’s best to think about 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 proscribed in comparison with Tier 1. Contributions to tier 2 NPS accounts don’t qualify for tax deductions beneath the sections we mentioned above. The account lacks the EEE tax standing as withdrawals are absolutely taxable as per your earnings slab. If you happen to’re eager about investing by way of the NPS tier 2 account for the mid to short-term, a gathering with a monetary advisor is perhaps useful. Although it doesn’t present tax benefits, the Tier 2 account’s versatile withdrawal guidelines may be engaging for some buyers.
Which Choice is Higher for Your Tax Planning?
So far as tax planning goes, there’s little question which between tier 1 and tier 2 NPS accounts could be the higher choose. With a number of tax advantages beneath Sections 80C, 80CCD(1B), and 80CCD(2), Tier 1 is the superior alternative. This account helps buyers cut back taxable earnings whereas constructing a retirement corpus. However, NPS tier 2 gives no main tax benefits.
Although it supplies higher liquidity and potential for development because of limitless fairness allocation, it lacks the EEE tax standing and makes withdrawals absolutely taxable. If you wish to save extra of your hard-earned cash, give our knowledgeable tax advisory providers a strive. Our advisors will help you construction your investments by way 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 function, tax advantages, and withdrawal guidelines. The Tier 1 account is designed for retirement financial savings and gives many advantages beneath the Revenue Tax Act. Because the Tier 2 account focuses primarily on investments, it supplies excessive liquidity however lacks any notable tax benefits.
