NPS Tier-2 Withdrawal: Will You Have to Pay Capital Gains Tax on Your Investments?
Income Tax 2025: The National Pension System (NPS) is one of the most popular retirement investment options 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 treatment of withdrawals from Tier-2 accounts is often misunderstood by investors. A recent case highlights this confusion, where an investor withdrew money from his NPS Tier-2 account and wanted to know whether capital gains tax would apply.
The Case of NPS Tier-2 Withdrawal
Manoj Sharma, an investor from Ghaziabad, had both Tier-1 and Tier-2 NPS accounts. On April 1, 2022, he invested ₹1 lakh in his Tier-2 account. However, due to a medical emergency, he withdrew the entire amount on June 15, 2024. His question: “Do I need to pay capital gains tax on the amount withdrawn?”
To clarify this, Moneycontrol consulted tax expert Balwant Jain, who explained how the tax rules apply in such situations.
Tax Benefits: Tier-1 vs Tier-2
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Tier-1 Account: Contributions in Tier-1 are eligible for tax benefits under the old regime, and deductions are available for employer contributions under Section 80CCD(2) in both old and new regimes. Withdrawals are also subject to specific tax rules. At the age of 60, an investor can withdraw up to 60% of the corpus, while 40% must be used to purchase an annuity from an insurance company.
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Tier-2 Account: Unlike Tier-1, contributions in Tier-2 accounts do not offer tax benefits, except for central government employees (who get tax advantages with a three-year lock-in). For all other investors, there is no upfront tax deduction.
Tax Treatment of Tier-2 Withdrawals
Since the Income Tax Act does not provide specific provisions for Tier-2 withdrawals, the general capital gains tax rules apply. Here’s how it works:
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Capital Gains Calculation
When investors contribute to NPS Tier-2, units are allotted based on the NAV (Net Asset Value) on that date. On withdrawal, the difference between purchase NAV and redemption NAV is treated as capital gains. -
Holding Period Rules
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Earlier, long-term capital gains (LTCG) applied if units were held for 36 months or more.
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From July 23, 2024, the holding period for LTCG was reduced to 24 months for most capital assets.
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For withdrawals made before July 23, 2024, the 36-month rule continues to apply.
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Indexation Benefit
For long-term gains, indexation benefit (adjusting purchase price with inflation) was available until July 23, 2024. After this date, indexation benefits on most assets have been withdrawn.
What It Means for Investors
In Sharma’s case, since he withdrew on June 15, 2024—before the July 23 amendment—he is eligible for indexation benefit. However, because he did not complete the 36-month holding period, his gains will be treated as short-term capital gains and taxed as per his income tax slab.
Had he withdrawn after July 23, 2024, and held the investment for at least 24 months, the gains would have qualified as long-term capital gains (LTCG) but without indexation benefits.
Key Takeaways for NPS Investors
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Tier-2 accounts do not offer tax benefits (except for central government employees).
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Withdrawals are taxed under capital gains provisions, similar to mutual funds or other capital assets.
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Holding period rules matter: 36 months before July 23, 2024; 24 months after that date.
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Indexation benefit is no longer available on Tier-2 withdrawals made after July 23, 2024.
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Short-term gains are taxed at your applicable income tax slab rate.
Expert Advice
Financial experts recommend using Tier-2 accounts primarily for liquidity purposes and not for tax planning. Since Tier-1 offers structured tax advantages and retirement security, Tier-2 should be considered more like an investment-linked savings account with flexible withdrawals but standard tax liabilities.
✅ Bottom Line: If you withdraw from your NPS Tier-2 account, capital gains tax will apply just like other investments. The tax liability depends on your holding period, withdrawal date, and whether indexation benefits are available. Always consult a certified tax advisor before making withdrawals to optimize your tax outgo.
