NPS: Features, Tax Benefits, and Eligibility for Tier 1 & Tier 2

IndiaFirst Life
• 16 Apr, 2025

The National Pension System (NPS) is a government-backed retirement savings scheme designed to provide financial security post-retirement. With increasing awareness about financial planning, NPS has gained popularity among individuals looking for stable and tax-efficient investment options. The scheme is divided into NPS Tier 1 and NPS Tier 2, each with unique benefits and eligibility criteria.

Understanding NPS Tier 1 vs NPS Tier 2 Scheme

NPS is structured into two account types:

NPS Tier 1:
A mandatory pension account with restrictions on withdrawals before retirement.
NPS Tier 2:
A voluntary account with more flexibility and liquidity, but without tax benefits.

Both tiers serve different purposes, catering to varying financial goals.

Benefits of NPS Tier 1 Scheme

Here are the advantages you will enjoy with the NPS Tier 1 Scheme:

Tax Benefits
Investments made in NPS Tier 1 qualify you for tax deductions under Section 80CCD(1) and 80CCD(1B).**
Long-Term Savings
The money you invest in NPS Tier 1 is locked-in until retirement, ensuring financial stability.
Government Contribution
Employees in government jobs receive additional contributions in NPS Tier 1.
Systematic Pension Growth
This scheme is managed by professional pension fund managers, ensuring expert guidance for systematic growth.
Annuity Option
After retirement, a portion of the corpus must be used to buy an annuity, ensuring a steady income.
Market-Linked Growth
Investments in NPS Tier 1 are allocated in market-linked funds, potentially yielding higher returns.

Benefits of NPS Tier 2 Scheme

Here is a look at the benefits of the NPS Tier 2 Scheme:

No Lock-In Period
NPS Tier 2 Scheme allows you to withdraw funds at any time as there is no lock-in period.
Higher Liquidity
This scheme offers higher liquidity as it functions like a mutual fund with better accessibility.
Diverse Investment Choices
Investing in NPS Tier 2 means allocation of funds in equity, corporate bonds, and government securities.
Flexibility in Contributions
Investors can contribute any amount at any time, unlike the mandatory structure of Tier 1.

Income Tax Benefit on NPS Tier 1 & Tier 2

There are certain benefits that are common across both Tier 1 and Tier 2 NPS Schemes. They are:

Contributions to NPS Tier 1 are eligible for deductions up to ₹1.5 lakh under Section 80CCD(1) and an additional ₹50,000 under Section 80CCD(1B).
Unlike Tier 1, NPS Tier 2 does not provide tax deductions, but offers higher liquidity.

NPS vs PPF: Which One is Better?

While both NPS and PPF (Public Provident Fund) are tax-saving options, the NPS vs PPF comparison highlights that NPS offers better retirement-focused returns with equity exposure. On the other hand, PPF is entirely government-backed, making it risk-free but with lower returns. The choice between the two depends on risk appetite and investment horizon. Tools like an NPS calculator can help compare the potential corpus growth under different scenarios.

Rules for Premature NPS Withdrawal

Partial withdrawals from NPS Tier 1 are permitted after 3 years for specific reasons like medical emergencies, higher education, or home purchase. However, full withdrawal is only allowed post-retirement.

Upon Superannuation:
60% of the accumulated corpus can be withdrawn tax-free, while 40% must be used for annuity purchase.
Before Retirement:
Premature exit requires 80% of the corpus to be invested in an annuity plan, with only 20% available as a lump sum.
In Case of Death:
The entire corpus is paid to the nominee.

Investment and Pension Schemes in NPS

The Unit-Linked Pension plan allows individuals to invest in different asset classes. Moreover, various pension schemes ensure a stable income after retirement. Investors can choose between active and auto investment modes.

Active Choice:
The investor decides the asset allocation between equity, corporate bonds, and government securities.
Auto Choice:
The asset allocation is determined based on the investor’s age, automatically reducing risk as they approach retirement.

Life Insurance and Retirement Plans

Many people combine life insurance with NPS for comprehensive financial security. Some retirement plans include additional benefits such as annuities to provide a steady income post-retirement. Opting for a Unit-Linked Pension Plan can provide a mix of insurance and investment benefits.

NPS Vatsalya Scheme: A Supportive Initiative

The NPS Vatsalya Scheme is an initiative designed to provide pension benefits to financially weaker sections, ensuring security in old age. This scheme primarily targets workers in the unorganized sector who lack formal pension coverage. Through this initiative, the government aims to include individuals who might otherwise be excluded from structured retirement savings plans.

The key features of the NPS Vatsalya Scheme include:

Government Co-Contribution:
Eligible beneficiaries receive additional contributions from the government to boost their pension corpus.
Lower Contribution Requirements:
Individuals can start with small contributions, making retirement savings more accessible to lower-income groups.
Tax-Free Pension Benefits:
The scheme provides tax-free benefits at the time of retirement, making it an attractive option for low-income earners.
Simplified Enrolment Process:
The registration process is designed to be straightforward, allowing more individuals to participate without complex documentation.
Encouraging Women’s Participation:
Special incentives are provided to encourage women from economically weaker backgrounds to enrol in the scheme, ensuring financial independence post-retirement.

Who Should Invest in NPS?

NPS is not just a retirement fund. It is a great investment opportunity for many people. Here are a few people that NPS helps the most:

Young Professionals:
Those who want to start early and benefit from compound growth.
Salaried Employees:
Especially those looking for additional tax savings beyond EPF contributions.
Self-Employed Individuals:
As an alternative retirement savings plan in the absence of employer-sponsored schemes.
Government Employees:
As part of their mandatory retirement planning.

Steps to Open an NPS Account

Here is how you can open an NPS account:

Step 1: Visit the official NPS website or a registered Point of Presence (PoP).
Step 2: Provide KYC documents like Aadhaar, PAN, and bank details.
Step 3: Select the type of account – NPS Tier 1 or Tier 2.
Step 4: Choose the fund manager and investment preference (active or auto choice).
Step 5: Complete the registration and start contributing regularly.

Additional Advantages of NPS

Choosing between Tier 1 and Tier 2 depends on each individuals financial goals and preferences. However, NPS as a whole is a extremely advantageous.

Portability:
NPS accounts are fully portable across jobs and locations, ensuring no disruption in retirement planning.
Choice of Fund Managers:
Investors can select from multiple fund managers, allowing them to optimize their portfolio’s growth.
Cost-Effective:
NPS has one of the lowest fund management charges compared to other retirement investment products.
Global Investment Practices:
The funds are managed by experts following international best practices to ensure transparency and efficiency.
Option for Partial Withdrawals:
Unlike traditional pension plans, NPS allows limited partial withdrawals for specific financial needs.

NPS is an excellent option for those looking to build a retirement corpus while enjoying tax benefits. Choosing between NPS Tier 1 vs NPS Tier 2 depends on one’s financial goals and liquidity needs. By investing wisely, individuals can ensure a financially secure retirement with NPS. Understanding the Rules for Premature NPS Withdrawal and making informed decisions about Unit-Linked Pension and NPS Vatsalya Scheme can further enhance retirement security. As financial awareness grows, NPS continues to be a reliable tool for securing the future.

by IndiaFirst Life
Headquartered in Mumbai, IndiaFirst Life Insurance Company Limited (IndiaFirst Life), with a paid-up share capital of INR 754.37 crore, is one of the fastest growing private life insurers in India in terms of New Business IRP in Fiscal 2023. Our key differentiators are our simple, easy-to-understand products that are optimally priced. As of Sept 30, 2023, we offered 30 retail products, 13 group products along with six riders (across retail and group portfolios), along with policies under the PMJJBY scheme, catering to protection, savings, health and retirement needs of our customers, leveraging multiple distribution capabilities and augmenting various investment options. In all propositions under the categories of Participating Plans, Non-Participating Savings Plans, Non-Participating Protection Plans, Unit Linked Insurance Plans, Group Protection Plans, Corporate Funds Plans, Riders & PMJJBY form a complete suite of offerings that help our customers prepare for the certainties of life. Our products are easy to understand and optimally priced with a developed comprehensive risk management framework/policy.