The National Pension System (NPS) is one of the most popular and reliable investment schemes for retirement planning. Along with helping individuals build a retirement corpus, NPS also offers attractive tax benefits. However, many people are unaware that NPS accounts are divided into two categories — Tier 1 and Tier 2, and both have different tax exemption rules.
If you are planning to invest in NPS, it is important to understand how much tax exemption you can claim under Tier 1 and Tier 2 accounts. Additionally, the tax benefits may differ based on whether you are opting for the old tax regime or the new tax regime.
In this article, we will explain the key differences between Tier 1 and Tier 2 accounts of NPS and how much tax exemption you can get.
✅ What is NPS and How Does It Work?
The National Pension System (NPS) is a government-backed investment scheme launched by the Pension Fund Regulatory and Development Authority (PFRDA) to ensure financial security after retirement. Under this scheme, individuals can contribute regularly and build a retirement corpus, which can later be withdrawn in the form of a pension or lump sum amount after retirement.
NPS offers two types of accounts to its subscribers:
- Tier 1 Account (Mandatory) – Designed specifically for retirement planning with tax benefits and a lock-in period until the age of 60.
- Tier 2 Account (Optional) – Acts as a voluntary savings account with no lock-in period and limited tax benefits.
✅ What Are the Tax Benefits Available Under NPS?
The tax benefits in NPS vary based on the type of account and the tax regime you choose (Old Tax Regime or New Tax Regime). Let’s break down the tax exemptions available under Tier 1 and Tier 2 accounts.
✅ Tax Exemption Benefits in NPS Tier 1 Account
The Tier 1 Account of NPS is specifically designed for retirement savings and offers attractive tax benefits. However, there are certain rules regarding withdrawals and tax deductions depending on whether you follow the old tax regime or the new tax regime.
Tax Benefits in the Old Tax Regime
If you opt for the old tax regime, you can claim tax benefits under the following sections of the Income Tax Act, 1961:
1. Deduction Under Section 80C
- You can claim a deduction of up to ₹1.5 lakh per financial year on your contribution towards NPS Tier 1.
- This deduction is part of the overall limit under Section 80C, which also includes LIC premiums, ELSS, PPF, etc.
2. Additional Deduction Under Section 80CCD(1B)
- Apart from Section 80C, you can claim an additional deduction of ₹50,000 per financial year under Section 80CCD(1B).
- This benefit is exclusive to NPS Tier 1 subscribers and can significantly reduce your taxable income.
- In total, you can claim up to ₹2 lakh per year (₹1.5 lakh under 80C + ₹50,000 under 80CCD(1B)).
3. Employer Contribution Exemption Under Section 80CCD(2)
- If your employer contributes to your NPS account, it is also eligible for tax exemption under Section 80CCD(2).
- The maximum exemption allowed is:
- 10% of your basic salary + dearness allowance (for private sector employees).
- 14% of your basic salary + dearness allowance (for central or state government employees).
- The best part is that this deduction is over and above the limits of Section 80C and 80CCD(1B).
How Much Tax Benefit Can You Claim in the Old Tax Regime?
| Tax Deduction Category | Maximum Tax Benefit | Applicable Section |
|---|---|---|
| Own Contribution | ₹1.5 lakh per year | Section 80C |
| Additional Contribution | ₹50,000 per year | Section 80CCD(1B) |
| Employer’s Contribution | 10% of salary (Private) / 14% of salary (Government) | Section 80CCD(2) |
| Total Maximum Deduction | ₹2 lakh + Employer’s Contribution | Applicable Sections Combined |
✅ Tax Benefits in the New Tax Regime
If you opt for the New Tax Regime (introduced in 2020), the tax benefits are slightly limited. Here's what you get:
- ✅ Employer’s Contribution Only:
- Under Section 80CCD(2), only your employer's contribution is eligible for tax exemption.
- The limit is:
- 10% of basic salary + DA (for private sector).
- 14% of basic salary + DA (for government employees).
- There is no exemption for your own contribution under Section 80C or 80CCD(1B) in the new tax regime.
✅ Tax Benefits in NPS Tier 2 Account
The Tier 2 Account in NPS is designed for voluntary savings and has different tax rules compared to Tier 1.
✅ 1. No Tax Benefit for Regular Investors
- If you invest in Tier 2 NPS, there is no tax benefit under Section 80C or 80CCD for regular taxpayers.
- You can withdraw money anytime without any restriction or penalty.
✅ 2. Tax Benefit for Central Government Employees
- However, Central Government Employees can claim tax benefits under Section 80C if:
- They invest in Tier 2 NPS Account.
- Maintain a lock-in period of 3 years.
- This special benefit is not available to private-sector employees.
✅ Key Differences Between Tier 1 and Tier 2 Accounts
Here is a quick comparison of tax benefits between Tier 1 and Tier 2 accounts:
| Feature | Tier 1 Account | Tier 2 Account |
|---|---|---|
| Tax Exemption | ✅ Available up to ₹2 lakh | ❌ Not available (except for govt. employees) |
| Lock-in Period | Till age 60 | No lock-in period |
| Withdrawal | Allowed after retirement | Anytime withdrawal |
| Purpose | Retirement planning | Savings account |
✅ Conclusion
The National Pension System (NPS) is undoubtedly a powerful investment tool that offers attractive tax benefits while ensuring financial security after retirement. However, it is crucial to understand the difference between Tier 1 and Tier 2 accounts to maximize your tax savings.
- If your goal is long-term retirement planning, opt for Tier 1 NPS and claim up to ₹2 lakh tax deduction.
- If you need flexible savings without a lock-in period, choose Tier 2 NPS, but keep in mind that it offers no tax benefits (except for central government employees).
✅ Pro Tip: Always consult with your financial advisor to decide whether you should opt for the old tax regime or the new tax regime to maximize your tax savings under NPS.
