Budget 2026: Expert flags NPS Tier‑2 tax gap, urges capital asset status

NPS comprises two distinct accounts: the Tier-1 retirement-oriented account and the Tier-2 voluntary investment account.

Tier-1 enjoys explicit tax incentives under Sections 80CCD(1) and 80CCD(1B) of the Income-tax Act. And the benefit can be claimed by only those who have opted for the old tax regime.

• An additional ₹50,000 deduction under Section 80CCD(1B), exclusive to NPS investors.

• Under Section 80CCD(2), salaried employees whose employers are enrolled in the NPS can claim this deduction, which is capped at 10% of their basic salary under the old tax regime.

This deduction is applicable in both the new and old tax regimes.

In the new income tax regime, your own NPS contributions (under Sections 80CCD(1) and 80CCD(1B)) are not eligible for deductions. However, employer contributions (up to 14% of Basic salary) remain tax-deductible under Section 80CCD(2).

For most investors, Tier-2 accounts currently do not offer any tax incentives on contributions. Additionally, gains from Tier-2 investments do not receive any preferential tax treatment and there is no clarity on taxation.

"Tax benefit for contribution to Tier-II account is available under Section 80C of the Income-tax Act, 1961 to only employees of the central government, and that too with three years’ lock-in for those who have opted for the old tax regime," said Mumbai-based tax and investment expert Balwant Jain.

Given that Tier-2 functions more like a market-linked investment product, experts argue that returns should be taxed as capital gains rather than regular income. “There is an urgent need for clarity on the taxation of NPS Tier-2 accounts. Since Tier-2 functions like a regular investment product, it should be treated as a capital asset for tax purposes," said Balwant Jain.

Although Budget 2025 introduced certain tax-related changes, including incentives for the NPS Vatsalya scheme, it did not address the taxation framework for Tier-2 account gains.

To improve the attractiveness of NPS Vatsalya, the Finance Minister announced a tax exemption for contributions up to ₹50,000 annually, with similar treatment to standard NPS accounts within prescribed limits. These benefits, however, are applicable only under the old tax regime.

Separately, the Pension Fund Regulatory and Development Authority (PFRDA) has updated withdrawal norms, allowing non-government NPS subscribers to withdraw up to 80% of accumulated funds at exit. For government employees, the withdrawal structure remains unchanged at 60% lump sum and 40% annuity.

Previously, withdrawals were capped at 60%, with the balance required to be invested in an annuity to provide periodic pension income.