Should you use NPS Tier II account instead of mutual funds

The impressive performance of various investment options under the National Pension System (NPS) account is attracting a lot of investor attention. Some investment experts believe that NPS subscribers should also start using the Tier II account for their investment needs.

NPS comes with two accounts: Tier I and Tier II. Tier I is the retirement account which gets a host of tax breaks, whereas Tier II is a voluntary account which allows NPS subscribers to invest and take out money anytime.

“You can invest in a Tier II account only if you have an active Tier I account. Investments in Tier II account don’t qualify for tax deductions,” says Suresh Sadagopan, founder, Ladder7 Financial Advisories. You will have to contribute at least Rs 6,000 per annum to keep your Tier I account active.


Unlike Tier I account, there are no withdrawal restrictions on Tier II account. Since Tier I is a retirement account, you can withdraw the money only when you reach 60 years, as a lumpsum withdrawal and a pension. If you are getting out of NPS before 60, you will have to use at least 80 per cent of the money to buy an annuity. You can also take the money out under some special circumstances like medical emergency.

Should you use it like a mutual fund scheme?

Investment experts don't think so.

If you have a short-term goal, it doesn’t make sense to invest in Tier II. You have a wider range of debt mutual fund options available in the market. You can choose a scheme, depending on your goal and risk appetite.

“You have much more options in mutual funds for a shorter duration, say, 1-3 years. There are liquid schemes, arbitrage funds, credit opportunities fund,” says Sadagopan.

It won't be a great idea to use NPS Tier II account for long-term investment needs either because it doesn't allow you to invest more than 50 per cent of your total corpus in stocks, say experts. “The equity exposure in equity-oriented schemes of NPS is limited to 50 per cent,” says Dilshad Billimoria, Director, Dilzer Consultants.

Equity is considered the best bet to create wealth over a long period because it has the potential to offer superior returns than other asset classes. So, you might be better off in a pure equity scheme or an equity-oriented hybrid scheme to achieve your long-term financial goals.

According to Value Research, UTI Retirement Solutions (Tier II equity-oriented scheme) has given the highest return of 12.02 per cent in the last three years. Equity-oriented hybrid category has returned 14.90 per cent during the same period.

“We have so far not recommended NPS Tier II account to any clients," says Billimoria. According to Sadagopan, one should either opt for a Tier I account to claim the tax benefit or invest in mutual funds for other investment needs.

Investments in NPS Tier I account qualify for tax deductions of up to Rs 1.5 lakh under Section 80CCD(1). NPS also qualifies for an exclusive tax deduction of Rs 50,000 under Section 80CCD(1B).