NPS Tier I vs Tier II: Which Account Locks Your Retirement Savings and Which Lets You Withdraw Anytime

Ask any new National Pension System (NPS) subscriber what the difference between a Tier I and a Tier II account is, and most will shrug. Yet the choice governs whether your money is locked until 60 or reachable next Tuesday. As the Pension Fund Regulatory and Development Authority (PFRDA) sets out on its All-Citizen model page, Tier I is the "default pension account under NPS" and is "treated as a retirement savings account", while Tier II is "available only to subscribers with an active Tier I account" and is described as an "investment account" with "no restrictions on withdrawals". This article unpacks that split across withdrawal rights, tax at exit, and a worked multi-year drawdown, so you know exactly which rupee is retirement money and which is not.

The Scheme Explained

NPS runs on two account types that share a single Permanent Retirement Account Number (PRAN). Tier I is the mandatory core. You cannot hold NPS without it, and per the PFRDA All-Citizen page it carries "lock-in periods" with "withdrawals follow[ing] strict regulations per PFRDA rules". This is the account that qualifies for the deductions people open NPS for in the first place.

Tier II is optional and voluntary. The PFRDA page is explicit that "at any time the subscriber can withdraw" from Tier II, and the editor's briefing for this piece confirms it "offer[s] unrestricted withdrawals with no additional annual maintenance charge". It behaves like a low-cost mutual fund wrapper that sits on top of your pension account, using the same fund managers and the same Equity (E), Corporate Bond (C), Government Security (G) and Alternative (A) asset classes, but without any lock-in.

Two structural rules bind the pair together. First, you can only open a Tier II account if you already hold an active Tier I account, as the PFRDA page states directly. Second, the linkage is not symmetric on the way out: per the briefing notes, "closing the Tier I account automatically and simultaneously closes the linked Tier II account." A Tier II balance can therefore be dragged shut by a Tier I exit you initiate for retirement reasons, so the two should be planned together rather than in isolation.

One eligibility carve-out matters for the diaspora. The PFRDA All-Citizen page notes that "NRIs/OCIs with Tier I accounts are not permitted to activate Tier II account." A non-resident can build the core pension pot but cannot bolt the flexible sleeve onto it, a point our NRI investment guides return to repeatedly.

On keeping the account alive, Tier I imposes a modest annual discipline: a minimum contribution of Rs 1,000 per financial year is required to keep the account from being frozen, with a minimum of Rs 500 per contribution. Tier II asks for a minimum of Rs 1,000 to open but sets no minimum annual balance, which is why it can lie dormant between withdrawals without penalty. You can model contribution schedules for both against a target corpus using the NPS calculator.

Because NPS is market-linked, neither tier carries a government-declared interest rate. That is a genuine difference from the small-savings alternatives retirees weigh alongside it. For the quarter July to September 2026 (Q2 FY 2026-27), the Public Provident Fund pays 7.1 per cent, the Senior Citizen Savings Scheme pays 8.2 per cent, and EPFO has retained 8.25 per cent on the Employees' Provident Fund for FY 2025-26. NPS returns, by contrast, float with the chosen asset mix and are not guaranteed.

Tax on Withdrawal

This is where the two tiers diverge most sharply, and where the search intent "which account locks your retirement savings" is really answered. The PFRDA page states plainly that Tier I is "eligible for tax benefits under the Income Tax Act, 1961", whereas Tier II is "not eligible for tax benefits". Translating that into the rules an individual subscriber actually files:

On the way in, Tier I contributions attract deductions under Section 80CCD of the Income Tax Act, 1961. Section 80CCD(1) sits within the Rs 1.5 lakh Section 80C ceiling, while Section 80CCD(1B) adds a further Rs 50,000 of deduction. Crucially, and this trips up many filers, the Section 80CCD(1B) deduction of Rs 50,000 is NOT allowed in the new tax regime; it is available only under the old tax regime. Only Section 80CCD(2), the deduction for an employer's contribution, survives into the new regime, where it is allowed up to 14 per cent of salary (basic plus dearness allowance) per the Income Tax Act.

On the way out of Tier I at superannuation, the headline concession is generous. Under Section 10(12A) of the Income Tax Act, the lump sum you take at exit, up to 60 per cent of the accumulated corpus, is exempt from tax. The remaining balance, at least 40 per cent, must be used to purchase an annuity; that annuity is not taxed at the point of purchase but the monthly annuity income is fully taxable at your slab rate in each year you receive it, in line with the treatment of an annuity as pension income.

Partial withdrawals from Tier I get their own shelter. Under Section 10(12B) of the Income Tax Act, a partial withdrawal of up to 25 per cent of the subscriber's own contributions is exempt from tax, and the PFRDA All-Citizen page confirms the "max 25% of contribution" cap. These withdrawals are permitted only for specified purposes such as higher education, marriage, medical treatment or buying a first home.

Tier II offers none of this. Contributions earn no deduction for an ordinary subscriber (the only exception is the central-government employee variant with a three-year lock-in that qualifies under Section 80C). More importantly, Tier II carries no notified exit exemption: because it is "not eligible for tax benefits" per PFRDA, gains are added to your income and taxed at your slab rate, with no equity-style long-term capital gains concession applying automatically. Contrast that with a direct equity investment, where under Budget 2024 rules long-term capital gains are taxed at 12.5 per cent above a Rs 1.25 lakh annual exemption. The absence of a clean, notified capital-gains route is the hidden cost of Tier II's liquidity, and you can compare the after-tax paths in our annuity vs SWP tool.

For context on where the annuity income lands, the FY 2025-26 new-regime slabs are nil up to Rs 4 lakh, 5 per cent from Rs 4 lakh to Rs 8 lakh, 10 per cent to Rs 12 lakh, and rising to 30 per cent above Rs 24 lakh, with a Section 87A rebate of up to Rs 60,000 for taxable income up to Rs 12 lakh. A modest annuity may therefore attract little or no tax for a retiree whose total income stays within the rebate threshold.

Worked Drawdown

Consider Meera, who reaches age 60 in 2026 with a Tier I corpus of Rs 1,00,00,000 (Rs 1 crore) and a separate Tier II balance of Rs 10,00,000. The figures for growth and annuity yield below are illustrative assumptions used only to show the mechanics; NPS itself declares no guaranteed rate.

Step 1: accumulation. Suppose Meera's final three years of Tier I compounding, on an illustrative 9 per cent annual return, take the corpus from roughly Rs 84.2 lakh to Rs 1 crore:

Step 2: the exit split. At 60, Meera takes the maximum 60 per cent lump sum, Rs 60,00,000, fully exempt under Section 10(12A) of the Income Tax Act. The mandatory 40 per cent, Rs 40,00,000, buys an annuity. At an illustrative annuity rate of 6 per cent per year, that Rs 40 lakh yields Rs 2,40,000 a year, or Rs 20,000 a month, taxable at slab.

Step 3: the multi-year income and tax. Assume the Rs 2,40,000 annuity is Meera's only taxable income. Under the FY 2025-26 new regime, income of Rs 2,40,000 is below the Rs 4 lakh nil-tax threshold, so the annuity is effectively untaxed, and the Section 87A rebate (up to Rs 60,000 for income up to Rs 12 lakh) provides further headroom should she add income later.

Step 4: the Tier II sleeve. Meera's Rs 10,00,000 in Tier II is not locked. She can redeem any part of it in a single day, with no annuity obligation and no lock-in, which is precisely what the PFRDA page means by "no restrictions on withdrawals". The trade-off is tax: any gain inside that Rs 10 lakh is added to her income and taxed at slab, with no Section 10(12A) exemption, because Tier II is "not eligible for tax benefits". If liquidity in early retirement matters more than the tax shield, the Tier II rupees are the ones to spend first; if not, the lump-sum-plus-annuity structure of Tier I does the heavy lifting. You can stress-test a full retirement income plan, including a safe drawdown rate, with the retirement drawdown calculator.

The lesson from Meera's numbers is that the two tiers are complementary, not competing. Tier I converts Rs 1 crore into a tax-efficient 60/40 exit; Tier II keeps Rs 10 lakh liquid for the emergencies a rigid pension cannot cover.

FAQ

Can I withdraw from NPS Tier II whenever I want?

Yes. The PFRDA All-Citizen page states that in Tier II "at any time the subscriber can withdraw", and the editor's briefing confirms Tier II offers "unrestricted withdrawals with no additional annual maintenance charge". There is no lock-in and no purpose test, unlike Tier I where withdrawals before 60 are capped and conditional.

Is Tier II eligible for the Section 80CCD(1B) deduction?

No. The PFRDA page is explicit that Tier II is "not eligible for tax benefits", so an ordinary subscriber gets no deduction on Tier II contributions. The Section 80CCD(1B) additional deduction of Rs 50,000 applies only to Tier I, and even there it is NOT allowed in the new tax regime; it is available only under the old tax regime, per the Income Tax Act, 1961.

What happens to my Tier II account if I close Tier I?

It closes with it. The briefing notes for this piece confirm that "closing the Tier I account automatically and simultaneously closes the linked Tier II account." Because Tier II can only exist alongside an active Tier I account, you cannot keep the flexible sleeve open after exiting the core pension account.

How much of my Tier I corpus can I take as a tax-free lump sum at 60?

Up to 60 per cent of the accumulated corpus is exempt under Section 10(12A) of the Income Tax Act at superannuation. The remaining 40 per cent or more must buy an annuity, whose monthly income is then taxable at your slab rate each year you receive it.

Can an NRI open an NPS Tier II account?

No. The PFRDA All-Citizen page states that "NRIs/OCIs with Tier I accounts are not permitted to activate Tier II account." A non-resident can hold and contribute to the Tier I pension account but cannot activate the voluntary Tier II sleeve on top of it.

How is a partial withdrawal from Tier I taxed?

A partial withdrawal of up to 25 per cent of your own contributions is exempt under Section 10(12B) of the Income Tax Act, and the PFRDA page confirms the 25 per cent cap is measured against contributions rather than the total corpus. Such withdrawals are allowed only for specified needs such as higher education, marriage, medical treatment or a first home.

Does NPS pay a fixed interest rate like PPF or SCSS?

No. NPS is market-linked, so neither tier carries a declared rate. For the July to September 2026 quarter, PPF pays 7.1 per cent and SCSS pays 8.2 per cent, and EPF pays 8.25 per cent for FY 2025-26, but NPS returns instead track the Equity, Corporate Bond, Government Security and Alternative asset mix you choose.