The National Pension System (NPS) has two accounts. Tier 1 is the pension account, with withdrawal limits and tax benefits. Tier 2 is an optional add-on that works more like an ordinary investment account: you can put money in and take it out whenever you like. This guide explains the current Tier 2 rules, what it costs, how it compares with Tier 1, and the one area where the rules are genuinely unclear: tax on withdrawals.
What Is NPS Tier 2?
PFRDA describes Tier 2 as "an optional investment account" for subscribers who already have an active Tier 1 account, and states plainly that it is not a pension account. The key features, from PFRDA's own FAQ:
- Eligibility: you need an active Tier 1 account (PRAN). NRIs and OCIs are not eligible for Tier 2.
- Minimum contribution: ₹1,000 to open the account, then at least ₹250 per contribution. There is no minimum annual contribution and no minimum balance.
- Withdrawals: permitted at any time, without restriction on amount or frequency.
- Exit load: none.
- Switch to Tier 1: you can move money from Tier 2 to Tier 1, but not the other way (a one-way switch).
- If you close Tier 1: the Tier 2 balance is paid out at the same time.
- Tax benefit: none on contributions or gains, except for Central Government employees who use the Tier 2 tax-saver option (see below).
Investment Choices in Tier 2
Tier 2 is invested through the same pension fund managers as Tier 1, but you can pick a different pension fund and a different mix for each tier. Under Active Choice, Tier 2 offers three asset classes, each of which can be up to 100% of your allocation:
| Asset class | What it holds | Maximum in Tier 2 |
|---|---|---|
| E: Equity | Indian shares | 100% |
| C: Corporate bonds | Corporate debt | 100% |
| G: Government securities | Central and state government bonds | 100% |
Asset class A (alternative investments) is not available in Tier 2. In Tier 1, Scheme A has itself been merged into Schemes C and E. Unlike Tier 1 Active Choice, Tier 2 has no age-based cap on equity.
Ten pension funds are registered with PFRDA: Aditya Birla Sun Life, Axis, DSP, HDFC, ICICI Prudential, Kotak Mahindra, LIC, SBI, Tata and UTI. In Tier 2 you can split your money across up to three of them for different asset classes. You can change your asset allocation four times a financial year and your pension fund once a financial year.
What Tier 2 Costs
From 1 April 2026, the investment management fee for non-government subscribers depends on the size of the pension fund:
| Pension fund's assets under management | Investment management fee (a year) |
|---|---|
| Up to ₹25,000 crore | 0.12% |
| ₹25,000–50,000 crore | 0.08% |
| ₹50,000 crore–₹1.5 lakh crore | 0.06% |
| Above ₹1.5 lakh crore | 0.04% |
On top of this are smaller charges from the central recordkeeping agency (CRA) and, if you invest through one, the point of presence (POP). Even with these, NPS is one of the cheapest ways to hold a diversified portfolio in India. A low fee is not the whole story, though: the fund's returns and your ability to stay invested matter more.
Tier 1 vs Tier 2 at a Glance
| Feature | Tier 1 (pension account) | Tier 2 (optional account) |
|---|---|---|
| Who can open | Indian citizens, including NRIs; entry age up to 85 | Tier 1 holders only; not NRIs or OCIs |
| Withdrawals before exit | Partial: 25% of your own contributions, up to four times before 60, at least four years apart | Any amount, any time |
| Normal exit (All Citizen) | After 15 years or at 60, whichever is earlier | Not applicable |
| At exit | Non-government: up to 80% lump sum, at least 20% in an annuity; corpus up to ₹8 lakh can be withdrawn in full | Not applicable |
| Equity | Limits depend on your age and the scheme you choose | Up to 100% |
| Tax on contributions | Deductions under sections 123 and 124(3) (old 80C and 80CCD(1B)), old regime only; employer contribution deductible in both regimes | None, except the government-employee tax-saver |
| Tax at exit | 60% of the corpus tax-free; annuity income taxed at slab | Unclear (see below) |
The Tier 1 exit and withdrawal rules above are from PFRDA's amendment of 19 December 2025. Our guide to the NPS annuity rules explains them in more detail, and you can project a Tier 1 corpus with the NPS calculator.
The Government-Employee Tax-Saver
There is one case where Tier 2 contributions earn a deduction. Schedule XV (paragraph 1(w)) of the Income-tax Act, 2025 lists contributions by a Central Government employee to the NPS additional (Tier 2) account, under a notified scheme, for a fixed period of at least three years. These count towards the overall ₹1.5 lakh limit of section 123 (old 80C), and like every section 123 deduction they are available only in the old tax regime. Money in this tax-saver variant is locked for the three years; ordinary Tier 2 money is not.
No other subscriber (private-sector employees, the self-employed, or state government employees) gets a deduction for Tier 2 contributions.
How Tier 2 Withdrawals Are Taxed
This is the honest answer: the Income-tax Act has no provision written specifically for Tier 2 withdrawals by non-government subscribers, and practice is divided.
- View 1, capital gains: Tier 2 money buys units at a daily NAV, so the gain on redemption is treated as a capital gain. NPS units are not mutual fund units, so the mutual fund rules (including the special rule for debt funds) do not apply directly.
- View 2, income at slab rate: the gain is treated as ordinary income and taxed at your slab rate in the year you withdraw.
It is not "EET". Non-government subscribers get no deduction going in, so the first "E" does not exist.
Our suggestion: because the law is silent, the cautious course is to report Tier 2 gains as income at your slab rate unless a tax adviser tells you capital-gains treatment applies in your case. Either way, keep your CRA transaction statements showing the purchase NAV and date of each contribution, so you can calculate the gain if asked. Do not treat Tier 2 withdrawals as tax-free; PFRDA itself says Tier 2 has no tax benefit on gains.
When Tier 2 Makes Sense, and When It Doesn't
Tier 2 is a reasonable fit if:
- you already have Tier 1 and want a low-cost, simple account for medium-term savings with no exit load;
- you want a way to top up Tier 1 later (using the one-way switch);
- you are a Central Government employee in the old regime who wants a three-year locked tax-saver option.
It is a weaker fit if:
- you want certainty on tax. Equity mutual funds have clear, settled rules (12.5% on long-term gains above ₹1.25 lakh a year);
- you want a wider choice of strategies than three asset classes run by pension funds;
- you are an NRI, as you cannot open Tier 2 at all. See NPS for NRIs for what you can do.
For long-term retirement money, compare Tier 1 itself with EPF, PPF and mutual funds; our comparison of retirement mutual funds, NPS and PPF sets out the trade-offs, and the NPS calculator shows what Tier 1 could produce.
How to Open Tier 2
- Make sure your Tier 1 account is active.
- Log in to your CRA account online (or ask your bank or POP) and choose to activate Tier 2.
- Pick your pension fund(s) and asset mix; they can differ from Tier 1.
- Make the first contribution of at least ₹1,000.
This article explains NPS Tier 2 rules. It is not tax or investment advice. Tax treatment of Tier 2 withdrawals is unsettled; consult a qualified tax adviser for your situation.
