NPS Tier 1 vs Tier 2: Difference and Tax Benefits

Financial planning has always been discussed among Indians. The most crucial aspect of one’s financial planning is retirement planning, especially for employed individuals. After retirement, paychecks stop coming, but bills do not. It can get difficult to manage if you don't start planning your retirement. You can opt to invest in various savings schemes for retirement. 

One such beneficial scheme is National Pension System. The government launched NPS in 2004. Here, you will learn what Tier 1 and Tier 2 are in NPS, their differences, tax benefits and more. 

NPS: A brief overview 

Launched in 2004, the National Pension System (NPS) is a government-sponsored pension program. Although it was initially solely available to government workers, the government made it available to everyone in 2009. Individuals can contribute to their NPS accounts while still working and withdraw once they turn 60.

In essence, NPS is an annuity product designed to act as a retirement fund once a person leaves the workforce. 

Tier 1 and Tier 2 NPS accounts are two different categories. As opposed to Tier 1, which serves as the principal NPS account for building a retirement fund, Tier 2 is similar to a voluntary savings account and provides greater flexibility for deposits and withdrawals.

NPS Tier 1 vs NPS Tier 2 

The below table illustrates the differences between NPS tier 1 and tier 2. 

Tax Benefits On NPS Tier 1 And Tier 2 returns 

You should be aware of the following NPS tier 1 and tier 2 tax benefits while investing:

• Under Section 80CCE, all NPS Tier 1 subscribers can claim a deduction of up to Rs.1.5 lakhs.
• The entire amount invested is tax-free if you purchase an annuity. However, the annuity's income will be taxed at the appropriate rates.
• When taking a lump sum payout after turning 60, up to 40% of the money is tax-free. With the balance, you have to buy an annuity with taxable returns.
• 25% of the withdrawn amount is tax-free in cases of partial withdrawals.
• Under Section 80CCD(1B), Tier 1 investors are qualified for an extra deduction of up to Rs.50,000. Remember that this discount is above the Rs.1.5 lakh deduction provided u/s 80CCD (1) of the Income Tax Act of 1961.

While filing your ITR, consider these elements and claim substantial tax cuts. However, only owners of Tier 1 NPS accounts are eligible for these perks.

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

Under Section 80CCD (1), Tier 1 investors may receive a tax exemption for an additional investment of up to Rs.50,000. Premature withdrawals and the purchase of annuities both qualify for deductions. 

There are no tax advantages for Tier 2 accounts. Your ability to decrease your yearly taxes is significantly reduced as a result. 

There are fewer options for withdrawals before maturity in Tier 1 accounts because they are significantly more restricted.

Tier 2 subscribers can make an early withdrawal to cover different expenses. Hence, Tier 2 subscribers can better manage all financial needs with the collected funds.

Both Tier 1 and 2 have advantages and disadvantages. So, one must choose one after giving it great thought.

Conclusion 

While most investments are made in Tier 1 or Tier 2 accounts, keeping both investments active is feasible. Hence, a new investor can open a Tier 1 and Tier 2 account simultaneously.