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Summary: The tax on an inherited portfolio is not called inheritance tax. It doesn't arrive at death. It arrives years later, when the nominee finally sells. And most investors building wealth for the next generation have never thought about it.
India has no inheritance tax. Yet your nominee can pay around Rs 39 lakh in tax on an inherited equity mutual fund portfolio worth Rs 3.5 crore, and zero on an inherited NPS account of the same value. The act of inheriting itself is never taxed. What happens after the nominee receives the asset varies widely by product, and most retirement portfolios are built without accounting for these differences.
What happens with mutual funds and shares
Two provisions of the Income Tax Act decide the outcome.
Section 49(1) says the heir inherits the original purchase cost. Section 2(42A) says the heir inherits the original holding period. The nominee's clock did not start the day they received the units. It started the day the deceased bought them.
When the nominee redeems, capital gains tax applies on the full appreciation since the original purchase date. For equity funds, that means 12.5 per cent long-term capital gains tax on gains above Rs 1.25 lakh in a financial year.
This is the tax tail. Decades of compounded appreciation are compressed into a single tax event when the nominee chooses to sell. Capital gains tax on equity is deferred, never eliminated.
What happens with NPS
The Finance Act, 2016, added a clean provision: the entire NPS corpus paid to the nominee upon the subscriber's death is fully exempt from tax. No carried-forward gains. No clock running from the deceased's first contribution. The full balance passes through under the proviso to Section 80CCD(3).
The policy logic is straightforward. NPS sits in the Exempt-Exempt-Exempt category. Contributions, growth, and exit are all designed to be tax-free. The death benefit was aligned with EPF and PPF, both of which also pass to the nominee tax-free.
One caveat. The exemption applies to the lumpsum. If the nominee buys an annuity from part of the corpus, the pension received later is taxable as ordinary income. For non-government subscribers, the nominee can take the entire corpus as a lumpsum, and the tax is zero.
The number
Take a 30-year SIP of Rs 10,000 a month in an equity fund. Total invested: roughly Rs 36 lakh. At a 12 per cent annualised return, the corpus at year 30 is around Rs 3.5 crore.
Unrealised long-term capital gain in the hands of the nominee: about Rs 3.14 crore. After the Rs 1.25 lakh annual exemption, tax at 12.5 per cent works out to roughly Rs 39 lakh, payable whenever the nominee redeems.
The same Rs 3.5 crore in NPS attracts zero tax on the nominee's lumpsum exit.
The planning implication
This is not an argument for shifting everything to NPS. NPS has a Tier-I lock-in to age 60, capped equity exposure, and restricted partial withdrawals. Mutual funds and direct equity offer what NPS cannot: full equity participation, complete liquidity, and short-horizon flexibility.
The argument is narrower. For wealth meant to pass to the next generation, NPS plays a role that no general-purpose equity asset can. It is the only equity-exposed Indian product that passes to the nominee with no tax tail. PPF and EPF do the same work for the fixed-income slice.
The case for NPS is usually argued on the basis of the Rs 50,000 deduction under Section 80CCD(1B). That is the small argument. The large argument is what happens to your nominee on the day they sell.
Also read:
I opened an NPS for the tax break. How do I get out?
How to revive your dormant NPS account
How to turn your NPS lumpsum into a 25-yr retirement income
This article was originally published on May 19, 2026.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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