NPS Tier I vs Tier II for individuals: which account gives tax benefits and which gives free withdrawals

The National Pension System runs two parallel accounts under one Permanent Retirement Account Number, and they behave nothing like each other. Tier I is the locked retirement account that carries every income-tax deduction the scheme is famous for. Tier II is an optional, no-lock-in pot that lets you pull money out on any working day but hands you no deduction at all. Choosing which one to feed, and in what order, is the single biggest lever an individual investor has inside the All Citizen Model administered under the Pension Fund Regulatory and Development Authority (PFRDA).

This guide sets out the current rules as they stand in August 2026, including the revised exit slabs notified through the PFRDA (Exits and Withdrawals) Regulations, 2015 as amended on 20 July 2026. Every deduction, exemption and withdrawal figure below is drawn from PFRDA and from the Income Tax Act, 1961, and you can model your own numbers with the NPS calculator.

The Scheme Explained

The All Citizen Model is open to any resident Indian, Non-Resident Indian or Overseas Citizen of India. On its NPS for All Citizen Models page, PFRDA states the eligible band as those "aged between 18 to 85 years", which is far wider than the entry window most savers assume. Both accounts sit under a single pension architecture, but only one of them is built for tax-advantaged retirement saving.

Tier I is the default account and the retirement engine. It is the account eligible for tax benefits under the Income Tax Act, 1961, and in exchange it accepts regulated withdrawals rather than free access, with the bulk of the money staying invested until superannuation at age 60. You cannot open the All Citizen Model without a Tier I account, and there is no upper ceiling on how much you may contribute in a year.

Tier II is optional and can only be opened by someone who already holds an active Tier I account. In return for carrying no tax benefit whatsoever, it removes every restriction: PFRDA describes it as allowing withdrawal at any time with no limits, which makes it closer to an open-ended mutual-fund folio than to a pension. One eligibility trap catches non-residents in particular: NRIs and OCIs who hold a Tier I account cannot activate Tier II at all, a limitation confirmed on the PFRDA All Citizen page.

The table below sets the two accounts side by side on the features that decide where your next rupee should go.

On the deduction side, the tax benefit that makes Tier I worth the lock-in flows through three sub-sections of Section 80CCD, and the regime you pick decides how many of them survive. Under Section 80CCD(1) an employee can claim up to 10% of salary (basic plus dearness allowance), and a self-employed subscriber up to 20% of gross income, all within the combined Rs 1.5 lakh ceiling shared with Section 80C. Section 80CCD(1B) adds a further Rs 50,000 on top of that ceiling, but Section 80CCD(1B) is not available in the new regime; the Income Tax Department allows this deduction only under the old regime. Section 80CCD(2), covering the employer's own contribution, is the exception that works in both regimes: up to 10% of salary under the old regime and 14% under the new regime.

The practical reading is stark. A salaried subscriber in the 30% slab who routes an extra Rs 50,000 a year into Tier I under Section 80CCD(1B) saves Rs 15,600 in tax every year (30% plus 4% health and education cess), but only if they remain in the old regime. Put that same Rs 50,000 into Tier II and the deduction is exactly zero. That gap is the whole argument for filling Tier I first.

Tax on Withdrawal

Tier I is where the exemptions live, and they are generous but capped. When you close the account at age 60 or later, Section 10(12A) exempts the lump sum you take "to the extent it does not exceed 60% of the total amount payable" at closure. The portion used to buy an annuity is not taxed at the point of purchase either; instead, the monthly pension the annuity later pays is taxable at your slab rate in the year you receive it. So the lump sum is tax-free up to 60%, and the annuity is taxed only as it trickles back to you.

The revised exit slabs notified on 20 July 2026 changed how much you are forced to annuitise. For non-government All Citizen subscribers, the mandatory annuity now depends on the size of the corpus rather than a flat 40% rule.

Two numbers now sit in tension for large corpuses. The PFRDA regulations let a subscriber above Rs 12 lakh take up to 80% as a lump sum because only 20% must be annuitised, yet Section 10(12A) still exempts only 60% of the corpus. Taking more than 60% in cash therefore pushes the excess outside the exemption, so the tax-clean choice for most retirees is to cap the lump sum at 60% and route the remaining 40% into annuity or a periodic payout. Model both splits against your slab before deciding, using the annuity vs SWP calculator.

Before 60, two other routes exist. A partial withdrawal is allowed once you have been a subscriber for at least three years; you may take up to 25% of your own contributions (not the employer's share and not the growth) for defined needs such as a child's higher education or marriage, a first home, or medical treatment, up to a maximum of four times before age 60. That 25% is exempt under Section 10(12B). A full premature exit before 60 is far harsher: at least 80% of the corpus must buy an annuity and only 20% comes back in cash, unless the corpus is Rs 5 lakh or less, in which case the entire amount can be withdrawn as a lump sum.

Tier II offers none of this. There is no Section 10(12A) exemption on the way out, no notified concessional treatment for non-government Tier II gains, and no annuity requirement. You get your flexibility, but the gains are taxable in the ordinary course, so a Tier II drawdown will usually carry a tax cost that the Tier I 60% lump sum avoids entirely.

Worked Drawdown

Consider Ravi, aged 30, who can spare Rs 1 lakh a year for retirement. He splits it evenly: Rs 50,000 into Tier I to capture the Section 80CCD(1B) deduction and Rs 50,000 into Tier II for flexibility. Assume, purely for illustration, a 9% annualised return; NPS returns are market-linked and not guaranteed, so treat this as an assumption rather than a promise. Because the contribution and the return are identical, both pots grow along the same curve.

At 60, Ravi holds roughly Rs 68.15 lakh in each account, but they exit on completely different terms.

From Tier I, because the corpus is above Rs 12 lakh, only 20% must be annuitised. Ravi instead takes the tax-optimal split: 60% as a lump sum, which is Rs 40.89 lakh and fully exempt under Section 10(12A), and 40% (Rs 27.26 lakh) into an annuity. At an illustrative annuity rate of 6%, that annuity pays about Rs 1.64 lakh a year, taxable at his slab as it arrives. Not a rupee of the Rs 40.89 lakh lump sum is taxed.

From Tier II, Ravi can withdraw all Rs 68.15 lakh on any day he likes, with no annuity forced on him. But there is no 60% exemption, so the gains component is taxable. The flexibility is real and valuable, yet it comes at a tax cost precisely because Tier II never demanded the lock-in that earned Tier I its exemption.

This is the core of a sound drawdown strategy for the All Citizen Model. Treat Tier I as the taxed-efficient base of retirement income: a large tax-free lump sum at 60 plus an annuity or a systematic periodic payout for longevity cover. Treat Tier II as the flexible buffer that sits alongside it, funding a gap year, a medical emergency or a bridge before the annuity starts, without ever locking your money away. Over the full 30 years, the corpus that ran through Tier I also generated up to Rs 15,600 a year of tax saving under the old regime that Tier II could never match, a cumulative advantage of nearly Rs 4.68 lakh before any compounding of those savings. Sequence your drawdown with the retirement drawdown calculator so that Tier I supplies the tax-free floor and Tier II absorbs the shocks.

FAQ

Which NPS account gives tax benefits, Tier I or Tier II?

Only Tier I. Contributions to Tier I qualify under Section 80CCD(1), the additional Rs 50,000 under Section 80CCD(1B) in the old regime, and the employer share under Section 80CCD(2) in both regimes. Tier II contributions carry no deduction at all for individual subscribers under the All Citizen Model.

Can I open a Tier II account without a Tier I account?

No. PFRDA permits Tier II only for those who already hold an active Tier I account. There is also a restriction for non-residents: NRIs and OCIs with a Tier I account cannot activate Tier II.

How much of my NPS corpus can I withdraw tax-free at 60?

Section 10(12A) exempts the lump sum up to 60% of the total corpus at closure. Even though the exit rules amended on 20 July 2026 let subscribers with corpuses above Rs 12 lakh take up to 80% in cash, only 60% is exempt, so most retirees cap the lump sum at 60% and annuitise the rest to stay tax-clean.

Is Section 80CCD(1B) available under the new tax regime?

No. Section 80CCD(1B) is not available in the new regime; the additional Rs 50,000 deduction is available only under the old regime. If you file under the new regime, the sole NPS deduction you retain is the employer contribution under Section 80CCD(2), capped at 14% of salary.

How many times can I make a partial withdrawal from Tier I?

Up to four times before age 60, provided you have been a subscriber for at least three years and each withdrawal is capped at 25% of your own contributions. Permitted reasons include a child's higher education or marriage, buying or building a first home, and medical treatment. Amounts within this 25% limit are exempt under Section 10(12B).

What happens if I exit NPS before 60?

A premature exit requires at least 80% of the corpus to be used to buy an annuity, with only 20% returned as a lump sum. The one relief is a small-corpus rule: if the accumulated pension wealth is Rs 5 lakh or less on the date of exit, you may withdraw the entire amount as a lump sum.

Should I use Tier II as a substitute for a savings account or mutual fund?

Tier II offers same-day liquidity and no lock-in, but it gives no tax deduction on the way in and no exit exemption on the way out. It suits a disciplined buffer alongside a fully funded Tier I account, rather than a replacement for it. Fill Tier I first to capture the deductions, then use Tier II only for money you may need before 60.