A few weeks ago, in a column on mutual fund taxation, I mentioned that NPS Tier II could be treated like a low-cost mutual fund. What I wrote was not accurate. While you can make investments in and redemptions from a Tier II account as is the case with mutual funds, these are not taxed like mutual funds. Since Tier II has no specific mention in the tax code, by default it falls under the general category of ‘Income from other sources’. This is added to your income in the year that it is realised and, therefore, taxed at the marginal rate. Thus, it does not have the tax advantage that mutual funds have. Of course, this is not as bad as interest income, which is taxed as you receive it. In Tier II, the money accumulates as long as you do not redeem it. So it plays a role in compounding the gains.

There’s a twist to this. An interesting thing about the NPS is that a one-way switch is available from Tier II to Tier I. Hence, at retirement (or whenever you exit from the NPS till age 70), the money accumulated in Tier II can be treated the same way as postretirement NPS withdrawals. This means that 60% of the withdrawal is tax-free. So, if you use 60% of the NPS corpus for lumpsum withdrawal and the remaining 40% for annuity purchases, you do not pay any tax. Only the annuity income you receive in subsequent years will be subject to income tax at the slab rate. For government employees, Tier II is available as one of the permissible Section 80C tax-saving options with a threeyear lock-in period.

Very few takers
Despite its advantages, not many NPS investors have opted for Tier II account.

This means that the Tier II account, instead of being considered a mutual fund alternative, is best regarded as an extra contribution towards your pension, albeit with better liquidity than the normal Tier I NPS account. You can let it accumulate and eventually use it to enhance your pension. I’m not sure how many people have done this till now, but the design of this asset class is best suited for use in this manner. Or, if you need the money at some point for any reason, you can withdraw it. Of course, the returns on the withdrawn amount will be considered as income, but at least full liquidity is available regardless of the purpose for which you want the money.

As most NPS members know, or should know, Tier I money is not completely illiquid and is also available for withdrawal, but only partially, and for specific purposes.

You can withdraw partially if you need funds for your children’s higher education or to finance their wedding expenses. Additionally, you can tap into your NPS funds if you plan to purchase a house or construct a residential property. The system also recognises health-related emergencies, allowing withdrawals to treat specified illnesses. In cases where the account holder suffers from a disability of more than 75%, partial withdrawals are permitted.

Where Tier II subscribers invest
Equity funds have attracted the bulk of investments in the Tier II account.

These are as one would expect. However, there are two more circumstances in which withdrawals are permitted, which don’t quite fit the pattern. One is ‘skill development/re-skilling or any other self-development activities’, and the other is ‘establishment of own venture or any startups’. I don’t know whether anyone uses these provisions, but the fact that they exist is interesting and useful.

The moral of the story is that the National Pension System is now a large and complex beast with many nooks and crannies that few people are familiar with. This is probably the fate of most such systems, and none of these detract from their basic utility for almost everyone.

How to activate Tier II account in the NPS
The Tier II account can be opened only if you have a Tier I account in the NPS. NPS investors can activate the Tier II account both offline and online. If taking the offline route, the applicant needs to download Annexure 1, fill it up and send it to the POP-SP where the account was opened. This form is under the ‘Subscriber registration’ section on the NPS website. You must provide bank account details to open a Tier II account because withdrawals will be directly credited to this bank account.

ONLINE ACTIVATION

• For the online procedure, visit the electronic National Pension System website (eNPS) and click on the Tier II activation tab. You will be asked for the PRAN (Permanent Retirement Account Number), your date of birth and PAN details. Click on ‘Verify PRAN’ to receive an OTP on your registered mobile number.
• After the PRAN is verified, fill in bank details and click on ‘Validate Aadhaar’. Note down the acknowledgement number displayed on the screen.
• You will then be asked to provide the nominee details. Upload the scanned copy of the PAN card and a cancelled cheque. Once the documents are ready, click on ‘Upload’.
• Once this is done, e-sign the application using your Aadhaar number. Then download the form, take a print, sign it, and send it to NSDL’s head office in Mumbai by registered post.