What is NPS Tier 2? Features, Benefits, and How it Works

What Is NPS Tier 2?

NPS Tier 2 is a voluntary savings account that is available to individuals who already have an NPS Tier 1 account. But the Tier 2 account is not strictly retirement-focused and has relaxed withdrawal restrictions compared to Tier 1. This makes it flexible and viable. The NPS Tier 2 account can be thought of as an additional investment account under the NPS with the following abilities:

• You can make market-linked investments
• You can withdraw the money anytime
• You can manage your investments with much more flexibility

Note: The NPS Tier 2 account does not offer any tax advantages that Tier 1 does (except in some cases to government employees).

Who Can Open an NPS Tier 2 Account?

The members cannot open their Tier 2 account independently, but rather it is linked to their Tier 1 account. But the government and private sector employees are both allowed to open Tier 2 accounts. Here are the requirements for a tier 2 account:

• The member needs an active NPS Tier 1 account
• The member needs a valid PRAN (Permanent Retirement Account Number)
• The member should complete the KYC verification process

Key Features of NPS Tier 2

Below are the key features of NPS Tier 2 accounts in detail:

1. No Lock-in Period

   This is one of the biggest advantages of an NPS Tier 2 account; there are no mandatory lock-in periods for most subscribers. The members can withdraw their funds whenever required.

2. No Mandatory Lock-In Period

   In Tier 1 accounts, the funds are locked until the member retires, but Tier 2 accounts allow them full access and flexibility.

3. Flexible Contributions

   Tier 2 accounts require a minimum initial contribution of ₹1,000 and a minimum subsequent contribution of ₹250. In some cases, a minimum balance requirement may apply to keep the account active. The members can comfortably and flexibly contribute as per their financial convenience.

4. Market-Linked Returns

   The members can invest their funds in:

   • Equity (E)
   • Corporate Bonds (C)
   • Government Securities (G)
   • Alternative Investment Funds (A) (subject to limits)

   The returns are not guaranteed; they are dependent on market performance and the fund manager's strategy.

5. Low Cost Structure

   This also applies to Tier 2 accounts. The NPS services charge the lowest for management among the Indian investment products in India, including the Tier 2 account.

How Does NPS Tier 2 Work?

The NPS Tier 2 works the same as Tier 1 accounts when it comes to investment techniques, but the withdrawal flexibility makes it different. This flexibility and the following functions make the Tier 2 account similar to a mutual fund that is within the NPS framework:

1. You make contributions to the Tier 2 account.
2. The investments are made based on the chosen asset allocation in either active or auto choice.
3. The units are distributed based on NAV, or the Net Asset Value
4. The investment's growth is dependent on the market performance.
5. The member can withdraw the funds without any penalties.

Investment Choices Under NPS Tier 2

The member has the following investment options for their NPS Tier 2 accounts:

1. Active Choice

   The members can decide the allocation of their investments by dividing them among:

   • Equity (E)
   • Corporate Bonds (C)
   • Government Securities (G)
   • Alternative Investment Funds (A)

2. Auto Choice

   In auto choice, the members do not need to monitor the performance as closely as they would on active choice, and it is lower in terms of risk as the market exposure is adjusted as the member nears the age of retirement. Asset allocation adjusts automatically based on age:

   • Aggressive Life Cycle
   • Moderate Life Cycle
   • Conservative Life Cycle

Minimum and Maximum Investment Limits

Here are the minimum and maximum contribution requirements for a Tier 2 limit:

• The member needs to make a minimum initial contribution of ₹1,000 (subject to updates)
• Afterwards, the member can make a minimum subsequent contribution of ₹250
• There are no max investment limits; the member can invest however much they like.

Taxation Rules for NPS Tier 2

The tax ruling for a Tier 2 is very different when compared to Tier 1. Here are the details:

For Private-Sector Employees

• There are no tax deductions under section 80C or 80CCD.
• Gains from NPS Tier 2 investments are taxed based on the asset allocation, similar to mutual funds.
• Like mutual funds, equity exposure decides your tax category

For Government Employees

Central government employees can get tax deduction under Section 80C even for Tier 2 investments if they agree to a 3-year lock-in.

Benefits of NPS Tier 2

Below are the benefits of choosing an NPS Tier 2 account:

Liquidity

The members can withdraw their funds anytime without any restrictions or rules, except for a few government employee cases that agree to the lock-in period.

Low Expense Ratio

NPS Tier 2 accounts generally have lower fund management charges compared to many mutual funds.

Diversified Investment

The members can invest in equity, corporate bonds, govt. securities, and other permitted asset classes.

Ease of Management

The members have online access to their accounts through the CRA portal and mobile app.

Complementary to Tier 1

The members can create a flexible investment bucket with retirement savings.

NPS Tier 2 vs NPS Tier 1

Here is a comparison between the two tier accounts:

NPS Tier 2 vs Mutual Funds

There are various investors who compare Tier 2 with mutual funds. Here is how they compare:

Who Should Consider Investing in NPS Tier 2?

Here is a list of the investors that should consider the NPS Tier 2 accounts:

Investors Seeking Low-Cost Investment

If you prefer your investments to be exposed to equity and debt at a lower cost, then Tier 2 may be ideal for you.

Individuals With Long-Term Perspective

The investments are liquid but need to be held for medium to long term for optimum results.

Those Already Investing in Tier 1

The Tier 2 accounts are additional accounts for diversified portfolios.

Government Employees Seeking Tax Benefits

The central government employees who are eligible can benefit from the tax deduction by locking in.

Who May Avoid NPS Tier 2?

Do not choose the NPS Tier 2 account if you are:

• An investor looking for tax savings.
• Someone who needs complete flexibility across different investment platforms.
• An investor looking for short-term gains.

How to Open an NPS Tier 2 Account

Given below is the process of opening an NPS Tier 2 account:

Online Process

1. Log in to the CRA website using your PRAN.
2. Select the option of Open Tier 2 Account (you should already have a Tier 1 account)
3. Complete the application process and the formalities.
4. To complete the process, make the initial contribution.

Offline Process

Submit your request through the Nodal office or point of presence to open a Tier 2 account with all the relevant details attached.

How to Withdraw from NPS Tier 2

Given below is the process of withdrawing from an NPS Tier 2 account:

1. Log in to the CRA website.
2. Choose the withdrawal option.
3. Enter the amount you wish to withdraw.
4. Confirm your bank details.
5. Submit the request after checking the details once more.

Risks Associated With NPS Tier 2

Here is a list of risks tied to the NPS tier 2, so you can understand if you want to invest in this option:

• The market fluctuations can affect returns.
• There are no guaranteed or promised returns.
• There is no guaranteed capital protection.
• The tax benefits are not as attractive as a Tier 1 account.

Conclusion

The NPS Tier 2 accounts are an additional investment account option under the NPS for the members who already have a Tier 1 account. The investment options are additional for this account, and it provides weaker tax benefits compared to a tier 1 account, but excels in providing liquidity, diversification of portfolio and freedom of investment.

The NPS Tier 2 account is ideal for investors who want flexible market-linked growth options in the NPS structure. But they need to consider their financial goals, investment period, risk calculation and have a tax strategy ready before they invest in a Tier 2 account for smooth functioning and satisfying results.