After the debt mutual fund taxation change from 1st April 2023, many readers have asked us if they can use NPS Tier 2 as an alternative—a discussion. We had previously discussed a related idea: Can I use NPS Tier II as a low-cost index fund?
All NPS pension fund managers provide portfolio details under “statutory disclosures” on their websites. For example,
SBI NPS Scheme C Tier II (Corporate bonds)
- Average Maturity of Portfolio (in yrs) 4.86
- Modified Duration (in Yrs) 3.65
- Yield to Maturity (%) (annualised)(at market price) 7.80
SBI NPS Scheme G Tier II (Govt bonds)
- Average Maturity of Portfolio (in yrs) 11.36
- Modified Duration (in Yrs) 7.02
- Yield to Maturity (%) (annualised)(at market price) 7.24
The Tier II G scheme holds long term bonds and will be quite volatile. The Tier II C scheme holds medium-term bonds and will still be volatile compared to a liquid fund. One should not use Tier II for short-term goals.
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So can I use NPS tier II as a tax-efficient long-term debt fund?
No one knows how NPS tier II is taxed. That is, there is no official documentation. Some CAs have opined that this automatically implies that tier II gains will be taxed as per slab as income from other sources. So the tax efficiency is not there.
Earlier, some “pundits” argued that if you invest in the C and G scheme, the returns will be taxed as a debt fund. So now that is again as per slab!
Some taxpayers happily assume the gains are tax-free, and some do not even show it in ITR. All this uncertainty is only until Tier II becomes popular. Then we will have a clear tax rule.
We recommend assuming tier II gains will also be taxed as per slab. They can then be considered a debt fund alternative for long term goals, provided an NPS Tier I account is already present. Please do not open an NPS account to get a Tier II account! Nothing special about both I and II tiers!
However, it must be clearly understood that returns are market linked and Tier II has no special advantage compared to a gilt fund or a corporate bond fund. Therefore do not recommend using Tier II as a replacement for debt mutual funds.