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 staff have 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 personal sector can put money into NPS. You will have heard folks speak in regards to the tax-saving and wealth-building advantages of NPS. However do you know that more often than not, they’re truly 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 goal.
For a lot of, NPS acts as a priceless 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 could be the correct 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 Improvement 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 below 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 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 greater returns with reasonable to excessive threat.
- Authorities Securities (G): Contains quick and long-term authorities bonds, state bonds, and different government-backed devices which give security but additionally decrease returns.
- Company Bonds (C): These are additionally fixed-income devices, however they provide barely greater 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:
Energetic Selection:
This selection 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 Different Belongings (A). By choosing this selection you’ll achieve the pliability to construct your portfolio based mostly in your threat tolerance and monetary targets. Nevertheless, you need 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%. When you go for energetic alternative, you’ll be allowed to alter the asset allocation twice a 12 months. You may alter your portfolio based mostly on market situations, threat tolerance, monetary targets, and circumstances.
Auto Selection:
Because the title suggests, on this possibility the allocation is completed 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. When you don’t need the effort of adjusting asset allocation on occasion, you possibly can 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’s because youthful people can usually tackle extra threat as they’ve the time to recuperate 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 necessary. 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 want. In contrast to the Provident Fund, there isn’t a most funding restrict in NPS. You need to, nonetheless, make a minimal contribution of Rs. 1,000 yearly to your Tier 1 account.
For the reason that most important goal of this account is to assist people construct a retirement corpus, it could 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 offers them with a daily pension after retirement.
Nevertheless, when you’ve got accomplished not less than 3 years within the NPS, you possibly can partially withdraw funds below particular circumstances, like financing your youngsters’s greater schooling, setting up a home, or masking medical emergencies. You may solely withdraw 25% of your contribution quantity and solely as much as 3 times throughout your NPS tenure.
Be aware that you could solely withdraw 25% of your contribution quantity, so should 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 below Sections 80C, 80CCD(1B), and 80CCD(2) of the Revenue Tax Act, making it one of the crucial tax-efficient funding choices accessible.
NPS Tier 2 Account
Shifting on to what’s tier 2 in NPS. That is an elective 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 energetic 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 greater 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 below 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 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 in control 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 very least Rs. 500 should 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 energetic Tier 1 account can open a Tier 2 account. |
| Sort of Account | This can be a necessary account for investing in NPS. | The Tier 2 account is elective. |
| Lock-in Interval | Funds in Tier 1 accounts are locked in until the buyers attain the age of 60. | No lock-in length in these accounts. |
| Withdrawals | 60% of the accrued 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 below particular situations after an preliminary lock-in of three years. | Tier 2 accounts don’t have any restrictions on withdrawals. |
| Asset Lessons | Tier 1 accounts provide 4 asset lessons: fairness (E), company bonds (C), authorities securities (G), and different property (A). | Solely three asset lessons are provided in Tier 2 accounts, one can’t put money into different property (A). |
| Energetic Selection Choice | You may select to allocate a most of 75% of your funds to equities within the Tier 1 account. | You may allocate the whole thing of your funds to equities if you want. |
| Tax Advantages | Tier 1 accounts provide vital tax benefits below Sections 80C and 80CCD(1B). They’re additionally EEE investments, making them one of the crucial tax-efficient autos accessible. | Tier 2 accounts provide very restricted tax benefits. |
The principle distinction between NPS tier 1 vs tier 2 accounts is their goal. For the reason that main objective of NPS is to assist folks plan for his or her post-retirement revenue, the extra common Tier 1 account is designed with strict withdrawal guidelines, necessary annuities, and wonderful tax advantages. Tier 2 is an elective funding account that provides higher liquidity however restricted tax advantages. An funding planner can assess your monetary profile and assist you decide whether or not the elective 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 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 below Sections 80C and 80CCD(1B). Mixed, these sections permit buyers to say deductions as much as Rs. 2 lakh per 12 months, however solely below the previous tax regime.
- The second exemption is within the accrual stage. As your funding grows, it should 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% should be used to purchase an annuity. The common revenue from annuity plans is taxable as per the investor’s revenue slab price. Even untimely withdrawals entice no tax.
Right here’s a extra detailed take a look at the NPS tier 1 tax profit:
Deductions below 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 below 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! Keep in mind that 80C and 80CCD(1B) advantages are solely accessible to buyers submitting their ITR below the previous tax regime.
Deductions below 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 below Part 80C and the extra Rs. 50,000 below Part 80CCD(1B). You may declare as much as 10% of your fundamental wage + dearness allowance as a deduction. This profit is likely one of the uncommon tax deductions accessible even below the brand new tax regime. It is best to take into account consulting an funding professional should you want to benefit from 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 below the sections we mentioned above. The account lacks the EEE tax standing as withdrawals are totally taxable as per your revenue slab. When you’re eager about investing by way of the NPS tier 2 account for the mid to short-term, a gathering with a monetary guide could be useful. Regardless that it doesn’t present tax benefits, the Tier 2 account’s versatile withdrawal guidelines may be enticing for some buyers.
Which Choice 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 below Sections 80C, 80CCD(1B), and 80CCD(2), Tier 1 is the superior alternative. This account helps buyers cut back taxable revenue whereas constructing a retirement corpus. However, NPS tier 2 gives no main tax benefits.
Regardless that it offers higher liquidity and potential for development attributable to 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 professional tax advisory providers a strive. Our advisors may also help you construction your investments by way of personalised planning, ensuring you maximise tax advantages whereas aligning them along with your long-term monetary targets.
Conclusion
The NPS tier 1 and tier 2 accounts differ primarily of their goal, tax advantages, and withdrawal guidelines. The Tier 1 account is designed for retirement financial savings and gives many advantages below the Revenue Tax Act. For the reason that Tier 2 account focuses primarily on investments, it offers excessive liquidity however lacks any notable tax benefits.
