What is NPS?
The National Pension System (NPS) is a government scheme to help you save for retirement.
You invest regularly, and your money is put into a mix of shares, bonds, and government securities to grow over time.
At retirement, 60% of your savings (including profits) is tax-free, while the remaining 40% is invested in an annuity plan which is used to provide a monthly pension, taxed as per your income tax slab rate. It also offers significant tax relief but only for NPS Tier-I account holders.
Yes, there are two types of NPS accounts. But how does it differ? Let’s find out—
Difference between Tier-1 and Tier-2 Accounts
| Category | Tier-l | Tier-ll |
| Purpose | Primary account with tax benefits and retirement benefits | Works like a mutual fund |
| Eligibility | Indians aged 18-60 | Only for Tier-l holders |
| Lock-in period | Until retirement (aged 60) | No lock-in |
| Premature withdrawals | 25% after 3 years for emergencies, education, home purchases / specific cases (max 3 times during investment tenure) | Anytime any amount |
| Withdrawal on maturity | No tax on maturity amount up to 60% | Similar returns as Tier-l, but entirely taxable |
Here’s a big difference:
No tax benefits of Tier-II Funds, but for Tier-I:
| Category | Contribution Type | Tax Exemptions | Tax regime |
| For salaried Individuals | Self-Contribution | Up to 10% of salary (Basics + DA) under Section 80CCD(1), within the ₹1.5 lakh 80CCE limit | old |
| Extra ₹50,000 under Section 80CCD(1B). | Old | ||
| Employer Contribution | Up to 10% of salary (Basic + DA) or 14% for central govt. employees under Section 80CCD(2). | Old | |
| Up to 14% of salary (Basic + DA) for all employees under Section 80CCD(2). | New | ||
| For Self-Employed Individuals | Self-Contribution | Up to 20% of gross income under Section 80CCD(1), within the ₹1.5 lakh 80CCE limit. | Old |
| Extra ₹50,000 under Section 80CCD(1B). | Old |
This means you can save up to ~₹65,000 or more from tax annually while securing your retirement, with an NPS Tier-I account, while there are no tax benefits for Tier-II accounts.
The Loophole!
Most people choose mutual funds for retirement, frustrated by Tier-I’s high lock-in period and no tax benefits of Tier-II. But what if we told you there’s a loophole?
You can invest in NPS Tier-II for mutual fund-like liquidity and switch to Tier-I at maturity to enjoy tax-saving benefits. Curious how it works?
You can move your Tier-II funds to Tier-I before turning 60 using a One Way Switch. This lets you withdraw 60% of the corpus tax-free, while the rest goes into annuities. And you can still have easy access to your money, since Tier-II funds are liquid.
Lets understand with the help of an example:
Two friends Ramesh and Suresh, aged 25 years, decided to invest ₹5000/ Month for retirement planning. Ramesh chose a mutual fund while Suresh chose the NPS loophole!
Let’s see how their investments turn out!
Step-by-Step Journey of Ramesh and Suresh
Tax Impact: Mutual Funds vs NPS Loophole
| Mutual Fund (Ramesh) | NPS (Suresh) | ||
| Total Investments | ₹21,00,000 | ₹21,00,000 | |
| Total Returns (12% pa) | ₹3,24,76,345 | ₹3,24,76,345 | |
| Tax on Maturity | ₹40,43,918 [@12.5% (LTCG)] | Not Applicable | |
| Withdrawal Amount | ₹2,84,32,427 (After Tax) | ₹1,92,92,878 [60% Total Corpus] | |
| Annuity Plan | Not Applicable | ₹1,31,83,467 [40% Total corpus] | |
| Tax on Annuity Plan | Not Applicable | ₹93,600 (as per his slab rate) | Monthly Pension: ₹64,953 Annual Income: ₹7,79,436 Tax / Year: ₹5,200 Annuity Plan Tenure: 17 yrs Total tax (17 yrs): ₹93,600 |
| Total Tax | ₹40,43,918 | ₹93,600 | |
| NPS Tax Savings | ₹39,50,318 |
Suresh’s strategy not only saved on taxes but also ensured a steady pension income!
Note: This comparison was only with Equity Fund, if Ramesh would have opted for a Debt Fund, his tax liability would have been ₹97,42,903 [₹3,24,76,345 @ 30% (assumed tax rate)].
How to Switch Funds from Tier-II to Tier-I in NPS?
Step 1: Visit the CRA website and download the UOS-S form.
Step 2: Enter your PRAN, personal details, and the amount you want to transfer, along with other details.
Step 3: Take the completed form to your POP-SP (the bank or institution where you opened your NPS account)
Step 4: The POP-SP will verify your PRAN, check your account details, and confirm everything is in order.
Step 5: Once your request is accepted, you’ll get a 17-digit receipt number as confirmation.
Step 6: The POP-SP will handle the rest and process your request in the CRA system.
That’s it! No extra documents needed. Your funds will be moved to your Tier-I account smoothly.
Note: This is a one-way switch. You can move funds from Tier-II to Tier-I, but not the other way around!
Conclusion
For long-term retirement planning, NPS Tier-I is highly tax-efficient, offering deductions on contributions and tax-free withdrawals (60% of the corpus). However, 40% is locked for annuity income, which provides steady retirement payouts.
While mutual funds are liquid and offer diverse options, they attract higher taxes, especially on long-term gains.
For those seeking liquidity and tax benefits, NPS Tier-II offers mutual fund-like flexibility and the option to transfer funds to Tier-I for tax-free maturity. But the 40% lock-in limits access to larger funds for immediate goals.
So, carefully consider your goals, liquidity needs, and the pros and cons of NPS before using this strategy.
Summary
Refer the image below for the summary of the entire Read. Hope you enjoyed the Read!
FAQs
Can I join NPS if I have EPF/PPF/ Superannuation Fund / Provident Fund?
Yes, NPS can be subscribed along with other pension schemes. However, individuals cannot hold multiple NPS accounts.
How much pension will I get in NPS?
It depends on contributions, returns, and the annuity plan chosen. No assured returns, as investments are market-linked.
What documents are required to open an NPS account for Indian residents?
A filled registration form, a recent photo, PAN, address proof, and bank account proof are required.
What is a PRAN?
PRAN (Permanent Retirement Account Number) is a unique ID for your NPS account, which remains unchanged despite changes in employment or location.
How can I evaluate my NPS investments?
Check pension fund returns published weekly on NPS Trust. Asset portfolios are also available online.
What happens if I stop NPS contributions?
The account remains active, but you cannot withdraw until retirement or premature exit rules are met.
