Chapter 02 · The national pension system
Two tiers, two jobs
The NPS has two tiers that look similar on a form and do different jobs. Tier I is the retirement account, with restrictions on taking money out. Tier II is an optional account with much easier withdrawals and without the retirement-account tax treatment. This chapter keeps them from being used as one bucket.
Tier I is the locked job
Money goes into Tier I for retirement. The regulator allows partial withdrawals in specified circumstances — the list and the fraction have been defined and revised in circulars, so confirm the current list before you rely on it for a house or a medical bill. The ordinary case is that this money is not available because a better fund had a good month. That inconvenience is the product. It stops retirement money from becoming this year’s holiday. Do not put, into Tier I, any rupee you may need for an expense you can already see.
Tier II is a voluntary savings account wearing the same overalls
Tier II lets you add money and take it out, on the operating rules in force, without the retirement lock-in. It uses the same universe of pension fund managers and asset classes. It does not automatically inherit the tax treatment of Tier I. Assume it does not, unless the current law says, in words you can point at, that your particular contribution qualifies. People open Tier II because the form was in front of them, then later discover they wanted a mutual fund with a different mandate and a different tax lot. Open it only if you have a reason to hold this specific, restricted menu of funds in a liquid account.
Side by side
| Tier I | Tier II | |
|---|---|---|
| Purpose | Retirement saving you intend not to touch | Optional saving, if you want this fund menu without the lock-in |
| Taking money out | Restricted. Partial withdrawal only in the cases the current rules allow | Allowed, on the operating rules, which you should still read |
| Tax | The retirement-account treatment, which depends on the year’s law and on your situation | Do not assume the Tier I treatment applies |
| What does not belong | The emergency fund, the house down-payment you will need in two years | Money you only put there because you could not tell the tiers apart |
A sensible order of operations
- Fill the emergency fund outside the NPS. Neither tier is a substitute for cash you can use this week without a form.
- Decide the retirement contribution you can sustain, and send that to Tier I.
- Choose the asset mix for Tier I on the basis of how many years you have, not on last year’s return.
- Only then ask whether Tier II solves a problem you actually have. If you cannot name the problem, leave it unopened.
- Once a year, read the statement: contributions credited, scheme, fees, and the current value. A contribution that never got credited is a quiet failure.
What to remember
- Tier I is the retirement account. The restrictions are the reason it works.
- Partial withdrawals exist only for the reasons in the current circular. Confirm them. Do not plan around a memory.
- Tier II is liquid relative to Tier I and is not, by default, the same tax decision.
- Do not park money with a date on it in Tier I.
- Leave Tier II closed unless you can say what it does that a fund outside the NPS does not.