The National Pension System (NPS) is considered one of the best options for retirement planning.
It has two types of accounts:
Tier-1 Account: Meant for long-term retirement savings. Withdrawals from this account follow clear tax rules.
Tier-2 Account: Works more like a savings account and allows flexible withdrawals, but the tax rules for withdrawals are not as clearly defined.
Tax expert Balwant Jain explains that while Tier-1 contributions offer tax benefits (especially under Section 80CCD(2) for employer contributions in both old and new regimes), Tier-2 contributions do not offer any tax benefits—except for central government employees, who get benefits with a 3-year lock-in.
Case Study: Tax on Withdrawal from Tier-2 Account
Manoj Sharma, a resident of Ghaziabad, invested ₹1 lakh in an NPS Tier-2 account on April 1, 2022.
He had to withdraw the full amount on June 15, 2024, due to a medical emergency.
His question: Will the capital gains be taxed?
Here’s what applies in his case:
NPS is not considered an equity mutual fund, so regular mutual fund tax rules don’t apply.
Also, it doesn’t fall under debt fund rules.
Therefore, general capital gains tax rules apply.
To qualify for long-term capital gains (LTCG), the investment must be held for:
36 months (if withdrawn before July 23, 2024)
24 months (if withdrawn after July 23, 2024)
Since Sharma withdrew the money before July 23, 2024, the 36-month rule applies.
However, he held the investment for just over 26 months, so it doesn’t meet the LTCG requirement.
Final Tax Impact on Sharma’s Withdrawal
His capital gains will be treated as short-term capital gains (STCG).
STCG is taxed as per his income tax slab.
The good news: Because he withdrew before July 23, 2024, he will still get the benefit of indexation, which helps reduce the taxable amount.
Important Notes for Investors
Units in NPS are allocated based on NAV (Net Asset Value) on the date of contribution.
Pension fund managers under NPS are not mutual funds, so different tax treatment applies.
For Tier-2 withdrawals, capital gains are treated like any other asset class – not equity or debt funds.
Indexation benefit is available only on long-term gains made before July 23, 2024.
Disclaimer: This explanation is based on expert opinion and general tax rules. Always consult a certified tax advisor before making any financial decisions.
