A lot of people will be spending less during this season due to Coronavirus pandemic and it makes sense to use the additional tax benefit available for you under the scheme National pension system also called NPS.
While NPS is slowly gaining popularity thanks to its low cost and host of tax-benefits, the choice of accounts offered in NPS tends to cause a lot of confusion at the time of investing.
When you want to invest in NPS, you first need to open an account under the Tier I before you can consider opening the Tier II account. It’s natural for people to wonder about the utility of two different accounts and why the Tier II account cannot be opened independently. You will be able to know the benefits of both accounts and should you go for the Tier II account later in this blog post.
Tier I and Tier II: Similar Structure Both Tier I and Tier II NPS accounts are similar. Both have similar charges and choice of fund managers and fund schemes. The asset classes in which the fund managers can invest is also the same. The Pension Fund Manager (PFM) charges 0.01% on the assets managed, and the custodian charging 0.0032% as an asset servicing charge. The POP has the same charges on every transaction when you put money in Tier I or Tier II NPS. You can also port across PFMs and fund options with both NPS Tier I and Tier II.
Tier I and Tier II: The differences NPS Tier I The subscription to NPS commences with the opening of the Tier I account, which comes with a PRAN (Permanent Retirement Account Number). Your investment in the NPS Tier I account is locked-in until the age of 60. Before the age of 60, you can make partial withdrawals for specific purposes or you can go in for a premature exit (as explained below). Under NPS Tier I, you can save and invest to claim the tax deductions available under version sections of the Income Tax. The tax benefits offered in NPS can be claimed only for the investments made in the Tier I account. NPS Tier II You can open the NPS Tier II account only when you already have a Tier I account.
Tier-II account is a voluntary account with flexible withdrawal and exit rules. Even though it works exactly like your NPS Tier I account, there are certain differences. Firstly, contribution to Tier II NPS has no tax benefits – you can’t claim deductions and on exit, the corpus is taxed. Unlike the Tier I account, there is no lock-in with savings in the Tier II account. You can withdraw from the Tier II account at any time. However, in functionality, both Tier I and Tier II are similar and so is the fund management costs as well as the choice of investments.
| Tier I and Tier II NPS | ||
| Tier I | Tier II | |
| Eligibility | Any Indian citizen between 18 & 65 years of age | Members of Tier I only |
| Lock-in | Till the age of 60 years | Nil |
| Minimum number of contributions in year | 1 | Nil, you can choose not to make any contribution in a year |
| Minimum contribution for account opening | Rs 500 | Rs 1,000 |
| Minimum amount for subsequent contribution | Rs 500 | Rs 250 |
| Minimum number of annual contributions | 1 | Not mandatory |
| Fund management charge | Charges are same for both Tier I and Tier II accounts | |
| Available asset classes | Same for both Equity (E): Scheme invests predominantly in Equity market instruments. Corporate Debt (C): Scheme invests in Bonds issued by Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), Infrastructure Companies and Money Market Instruments Government Securities (G): Scheme invests in Securities issued by Central Government, State Governments and Money Market Instruments Alternative Investment Funds (A): In this asset class, investments are being made in instruments like CMBS, REITS, AIFs, etc. | |
| Tax benefits on contribution | Contribution to NPS Tier I qualify for tax deduction under Section 80C up to Rs 1.5 lakh. Tax deduction is available under Section 80CCD (1B) up to Rs 50,000 in addition to Section 80C benefits. | No tax benefit |
| Taxation on withdrawal | At maturity, the entire corpus is tax-exempt | The entire corpus can be withdrawn, which is added to income and taxed as per the tax slab one falls in |
You know that structurally, all aspects of Tier I and Tier II NPS are the same. The choice of the available asset class to invest, option among fund manager, and charges are also the same. Yet there is a case to invest in Tier-II NPS sans the tax benefits. The reason: if you are new to investing and have a Tier I NPS account, you could consider NPS Tier II as an open-ended mutual fund to invest towards any surplus savings. The limited equity exposure of up to 75% in the case of NPS, limits the risk of volatility with equity, which is much desired by first-time investors.
Moreover, you can benefit from the low investment cost as the Pension Fund Manager (PFM) charges is 0.01% on the assets managed and the overall cost of the NPS is the lowest compared to mutual funds. With no lock-in, the flexibility to withdraw from Tier II account allows you to dip into the savings in the account whenever you need, which makes the case to invest in Tier II NPS.
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