The National Pension System (NPS) is one of the most popular options for retirement planning in India. It offers two types of accounts: Tier-1 and Tier-2.
While the tax rules for Tier-1 withdrawals are well defined, the rules for Tier-2 withdrawals are not very clear.
Case in Point:
Manoj Sharma, a resident of Ghaziabad, had opened both Tier-1 and Tier-2 accounts. He invested ₹1 lakh in his Tier-2 account on April 1, 2022.
However, due to a medical emergency, he withdrew the entire amount on June 15, 2024. He now wants to know if he has to pay capital gains tax on the withdrawal.
Expert View:
Tax expert Balwant Jain, in a conversation with Moneycontrol, explained the tax implications.
Tax Treatment of NPS Accounts:
Contributions to the Tier-1 account are tax-free under the old tax regime.
Under Section 80CCD(2), the employer’s contribution to Tier-1 is tax-deductible under both old and new regimes.
The Tier-2 account, however, does not offer tax benefits, except for Central Government employees, and only with a 3-year lock-in period.
Tier-1 Withdrawal Rules:
At retirement, the subscriber can withdraw 60% of the amount tax-free.
The remaining 40% must be used to buy an annuity (a regular pension) from a life insurance company.
Tier-2 Withdrawal Rules:
Since there are no specific tax rules for Tier-2 account withdrawals, general capital gains tax rules apply:
When you invest in NPS, you get units based on the NAV (Net Asset Value) of that date.
However, NPS is not treated like equity mutual funds, as pension fund managers are not classified as mutual funds.
Hence, the 36-month holding period applies to qualify for long-term capital gains (LTCG).
This means, debt fund rules or equity fund rules don’t apply to Tier-2 accounts.
How Capital Gains Are Taxed in Tier-2:
If the withdrawal is before completing 36 months, the gains are considered short-term and taxed as per the investor’s income tax slab.
If withdrawn after 36 months, it’s treated as long-term capital gain (LTCG).
However, this rule changed from July 23, 2024:
For withdrawals before July 23, 2024, LTCG applies after 36 months.
For withdrawals on or after July 23, 2024, the LTCG period is reduced to 24 months.
What About Indexation?
Indexation benefit (adjusting the cost for inflation) for LTCG is not available after July 23, 2024, on most assets (except land and buildings).
Since Sharma withdrew the amount before July 23, 2024, he would get indexation benefit, but:
He held the investment for just over 2 years, which is less than 36 months.
So, he does not qualify for LTCG treatment or indexation.
Conclusion:
Since Sharma held the Tier-2 investment for less than 36 months, the capital gains will be treated as short-term.
Therefore, the gains will be taxed as per his income tax slab rate, and no indexation benefit will apply.
