It is very important to plan your retirement during your active professional journey. In this regard, the National Pension System (NPS) requires special mention. It is an initiative by the Indian government to provide people with financial backup when they retire. The NPS Scheme isn’t just a savings tool; it’s a structured way to build your post-retirement income, and it comes with some tax advantages that are hard to ignore.
What Makes NPS Stand Out
Anyone between 18 and 70 years old can open an NPS account. Managed by professional fund houses under PFRDA oversight, it offers a good mix of market-linked instruments. So, while the returns aren’t fixed like a PPF, they’re often better over the long run.
There are two accounts under NPS. Tier 1 is the primary retirement account. Tier 2 is optional and works more like a savings-plus-investment account. People lean heavily on Tier 1, but Tier 2, if used well, can be very useful. To avail the optimum benefits, you need to understand the core differences between the two:
Key Differences between Tier 1 and Tier 2
Feature | Tier 1 | Tier 2 |
Purpose | Retirement Savings | Flexible Investments |
Tax Benefits | Yes, up to ₹2 lakh | No (except govt employees) |
Lock-in Period | Until age 60 | None |
Minimum Yearly Investment | ₹1,000 | ₹250 |
Withdrawals | Restricted | Unrestricted |
Partial Withdrawal | Allowed under the rules | No restrictions |
Tier 1 is what you rely on for retirement. It’s got the structure, the discipline, and the tax benefits. Tier 2 is like a responsive investment wallet. You can dip into it when needed without worrying about penalties or formalities.
Tier 1 for Discipline, Tier 2 for Flexibility
If you are only putting money into Tier 1, you’re not getting everything you can out of the system. People who understand the financials usually invest in both. Tier 2 gives you market exposure, just like mutual funds, but with significantly lower management fees. That means more of your money stays invested.
Don’t get caught up in trying to figure out which tier pays more. The returns in both are driven by your asset allocation and the fund manager’s performance. Equity, corporate bonds, government securities, and alternative assets are all part of the mix.
If you choose Active Choice, you decide how much to allocate to each option. With Auto Choice, the system adjusts the mix as you age. Either way, you have control and visibility.
Tier 2 follows the same asset strategy. If your fund manager is delivering solid returns in Tier 1, chances are Tier 2 is performing well too.
Ways to Maximise Your NPS Strategy
This is where most people miss out. They open an NPS account, put in the bare minimum, and forget about it. But if you’re strategic about how you use both tiers, you can get better returns without taking on too much risk. Let’s discuss a few practices that make a difference:
- Take full advantage of tax breaks: You can invest up to ₹1.5 lakh under Section 80C (as per the old regime) and another ₹50,000 under 80CCD(1B). That’s a potential tax saving of ₹46,800. Add to that employer contributions under 80CCD(2), and you’re looking at one of the most tax-efficient ways to save.
- Use Tier 2 like a high-performance savings tool: Tier 2 gets you better returns, and you still have access to the money when needed. It’s a practical option for medium-term goals like a home down payment or funding a sabbatical.
- Switch fund managers if needed: Not all pension fund managers perform the same, and you’re allowed to switch once a year. So if one isn’t delivering, move to another. Performance tracking is available online, and you have to make it a point to review it once every 12 months.
- Use the NPS Calculator smartly: Premium insurers like Axis Max Life Insurance have an NPS Calculator that you can use to map out real-life situations. Try different monthly amounts, retirement ages, and annuity percentages. It helps you visualise your retirement, not just calculate it.
Understand the Withdrawal Gameplan
Withdrawal rules matter more than most people realise. Tier 1 doesn’t allow you to take out the full amount post-retirement – only 60% of the corpus can be withdrawn tax-free. The rest must be used to buy an annuity. These annuities provide you with a regular pension but are taxed according to your income bracket.
However, there’s an exception. If your total corpus is less than Rs. 5 lakh at the time of retirement, you can withdraw the full amount without purchasing an annuity. This is a helpful provision, especially for people with smaller savings or irregular income.
On the other side, Tier 2 withdrawals are simple. No lock-ins, no questions asked. You can just redeem the funds.
Equity Exposure Can Give You an Advantage
There’s one more reason to consider NPS over traditional tools. The equity component. Up to 75% of your money can go into equities if you start early. That kind of allocation isn’t possible in instruments like PPF or fixed deposits. And over time, this can make a profound difference.
Of course, the exposure gradually reduces with age. This auto-balancing feature protects you from volatility as you get closer to retirement. Still, the early years, say, your 20s and 30s, are ideal for maximising growth.
Also, remember that NPS works best when paired with complementary tools. A retirement strategy that only relies on NPS might miss a few pieces. That’s where other investment-linked insurance plans come in.
Many people now go for hybrid solutions or tax-saving investment plans that offer guaranteed returns along with life cover. Providers like Axis Max Life Insurance design such products to help you save, invest, and insure in one go.
It’s a good idea to look at both. Let NPS build your pension, and let your insurance plan offer a safety net for your family while growing your wealth.
Conclusion
When it comes to choosing NPS, it is not about picking Tier 1 and Tier 2, but in fact, it’s about using both wisely. Tier 1 gives you structure and tax benefits, while Tier 2 offers liquidity and speed. If you have the right fund manager, start early, adjust your exposure, and check your progress regularly using the NPS calculator provided by premium insurance providers like Axis Max Life Insurance, you will build not just a retirement plan but a future-proof financial strategy.
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Disclaimer: The content on this page is generic and shared only for informational and explanatory purposes. It is based on several secondary sources on the internet and is subject to change. Please consult an expert before making any related decisions.
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Tax benefit is subject to change as per the prevailing tax laws.