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Personal Finance | 10 June 2026
The National Pension System is India’s most tax-efficient savings instrument on paper. Your own contributions qualify for deduction within the Rs 1.5 lakh ceiling under Section 123 of the Income Tax Act 2025 (the successor to Section 80C), with an additional exclusive Rs 50,000 over and above that ceiling under Section 124(3) (the successor to Section 80CCD(1B)). Your employer’s NPS contribution is separately deductible under Section 124(1) and 124(2) – at 10 percent of basic salary under the old regime for private-sector employees, and at 14 percent under the new regime for all employees. For someone in the 30 percent bracket, the combined saving can reach up to Rs 62,400 per year. But here is what the brochure never leads with: at retirement, a mandatory 40 percent of your accumulated corpus is locked into an annuity that pays 5.5 to 7.5 percent per annum, and every rupee of that pension income is fully taxable under the head “Salaries” at your applicable slab rate. This article runs the real numbers – what the tax benefit actually saves you across a career, and what the annuity lock truly costs you at the other end.
Table of Contents
- Part I: How NPS Tax Benefits Actually Work Section 123 and 124 of the Income Tax Act 2025 – what each covers, the limits, and which regime applies
- Part II: The Lifetime Tax Saving – the Number People Cite What a 30-year career of NPS investing saves in taxes, with worked examples across income brackets
- Part III: The Annuity Lock – the Number Nobody Calculates How the 40% mandatory annuity works, what it pays, and the true cost in rupees at retirement
- Part IV: The EET Problem – When Your Pension Becomes Taxable Income Why NPS is EET and not EEE, how annuity income is taxed under Salaries, and what it means for your effective return
- Part V: NPS vs PPF vs ELSS – An Honest Side-by-Side Liquidity, taxation at exit, flexibility, and effective post-tax returns compared across the main instruments
- Part VI: Who Should Still Use NPS – and Who Should Think Twice The profiles for whom NPS genuinely wins, and the situations where the annuity cost outweighs the entry benefit
- Frequently Asked Questions
Rs 2L
Maximum own-contribution deduction per year – Rs 1.5L within Section 123 (old 80C) plus Rs 50,000 exclusively under Section 124(3) (old 80CCD(1B)) – under the old tax regime only.
40%
Mandatory minimum of your NPS corpus that must be used to purchase an annuity at retirement per PFRDA rules. Exempt from tax at the point of corpus transfer per Schedule VII, Table Sl. No. 6 of the IT Act 2025, but fully taxable once pension payments begin.
5.5-7.5%
Current annuity rates offered by PFRDA-empanelled Annuity Service Providers (ASPs) such as LIC, SBI Life, and HDFC Life. Annuity income is taxed under the head “Salaries” per Section 16(b) of the IT Act 2025 at your applicable slab rate.
EET
NPS follows Exempt-Exempt-Taxed for the annuity portion. The 60% lump sum is fully exempt per Schedule VII, Table Sl. No. 6. PPF and EPF follow EEE – fully exempt at all three stages.
Part IHow NPS Tax Benefits Actually Work
The Statutory Framework: Sections 123 and 124 of the Income Tax Act 2025
Under the Income Tax Act 2025, which governs all tax years from FY 2026-27 onward, the deduction provisions formerly known as Sections 80C and 80CCD have been consolidated and renumbered. Section 80C is now Section 123, which allows a deduction of up to Rs 1,50,000 on the aggregate of qualifying investments listed in Schedule XV. Section 80CCD – covering NPS-specific deductions – is now Section 124, with three operative sub-sections that map directly to the three buckets investors have always navigated.
Income Tax Act 2025 – Key NPS Provisions
Section 123: Deduction up to Rs 1,50,000 on aggregate of Schedule XV investments (replaces Section 80C of the old Act). NPS own-contributions by salaried employees (up to 10% of basic+DA) and self-employed individuals (up to 20% of gross total income) are included in Schedule XV, Paragraph 1(y) – within this Rs 1,50,000 ceiling.
Section 124(1): Employer’s NPS contribution is deductible – at 14% of salary for Central/State Government employers, and at 10% of salary for all other (private sector) employers, under the old tax regime.
Section 124(2): Where the assessee’s income is charged to tax under Section 202(1) (the new tax regime), the 10% limit in Section 124(1)(b) is substituted with 14% – meaning private-sector employees get 14% employer deductibility only under the new regime.
Section 124(3): An additional deduction of up to Rs 50,000 for own NPS contributions – entirely over and above the Rs 1,50,000 ceiling of Section 123. Available only under the old tax regime (Section 202(2)(a)(xii) excludes Chapter VIII deductions, other than Sections 124(1), 124(2), and 125(2), under the new regime).
Section 124(6): Any amount received on closure or opting out of NPS, or as pension from the annuity plan, is deemed to be the income of the individual in the year of receipt and charged to tax accordingly.
Section 124(1): Employer’s NPS contribution is deductible – at 14% of salary for Central/State Government employers, and at 10% of salary for all other (private sector) employers, under the old tax regime.
Section 124(2): Where the assessee’s income is charged to tax under Section 202(1) (the new tax regime), the 10% limit in Section 124(1)(b) is substituted with 14% – meaning private-sector employees get 14% employer deductibility only under the new regime.
Section 124(3): An additional deduction of up to Rs 50,000 for own NPS contributions – entirely over and above the Rs 1,50,000 ceiling of Section 123. Available only under the old tax regime (Section 202(2)(a)(xii) excludes Chapter VIII deductions, other than Sections 124(1), 124(2), and 125(2), under the new regime).
Section 124(6): Any amount received on closure or opting out of NPS, or as pension from the annuity plan, is deemed to be the income of the individual in the year of receipt and charged to tax accordingly.
Three Buckets – What Each Actually Covers
The first bucket is your own voluntary contribution, governed by Schedule XV, Paragraph 1(y) read with Section 123. For salaried individuals, this deduction is available up to 10 percent of basic salary plus dearness allowance. For self-employed individuals, the limit is 20 percent of gross total income. Critically, in both cases this deduction is subsumed within the overall Rs 1.5 lakh ceiling of Section 123 – meaning if you have already used up that ceiling through EPF, life insurance premiums, ELSS, or home loan principal repayment, your NPS own-contribution in this bucket delivers no additional tax benefit. The 20 percent limit for the self-employed is not a standalone entitlement of Rs 8 lakh on a Rs 40 lakh income – it is simply the percentage cap that applies within the Rs 1.5 lakh ceiling.
The second bucket is Section 124(3), formerly Section 80CCD(1B). This is the provision that makes NPS genuinely distinct from every other instrument: it allows an additional Rs 50,000 deduction for your own NPS contributions, entirely over and above the Rs 1.5 lakh Section 123 ceiling. This bucket is available only under the old tax regime. For a taxpayer in the 30 percent bracket, this single provision saves Rs 15,600 annually in income tax, or Rs 4,68,000 over a 30-year career in nominal terms before any compounding benefit on the tax saved.
The third bucket is Section 124(1) and 124(2), formerly Section 80CCD(2). This covers your employer’s NPS contribution. Here is the critical distinction that the Income Tax Act 2025 makes explicit, and which is frequently misrepresented: under the old tax regime, private-sector employers can deduct NPS contributions up to 10 percent of salary under Section 124(1)(b). Government employers (Central and State) get 14 percent under Section 124(1)(a). Under the new tax regime (Section 202(1)), Section 124(2) upgrades the private-sector limit from 10 percent to 14 percent as well – giving all employers parity at 14 percent under the new regime. This distinction matters enormously for employees deciding between regimes.
Regime eligibility – precisely stated per the IT Act 2025: Under the old tax regime, all three deduction buckets are available – Schedule XV/Section 123 (own contribution within Rs 1.5L ceiling), Section 124(3) (additional Rs 50,000), and Section 124(1) (employer contribution at 10% for private, 14% for govt). Under the new tax regime (Section 202(1)), only the employer contribution under Sections 124(1) and 124(2) is available – and at 14% of salary for all employers, including private sector. Your own NPS contributions give you zero income tax deduction under the new regime. Section 202(2)(a)(xii) of the IT Act 2025 expressly excludes all Chapter VIII deductions except Sections 124(1), 124(2), and 125(2) when computing income under the new regime.
What the Numbers Look Like in Practice
Consider a salaried individual earning a gross annual income of Rs 20 lakh under the old tax regime, with a basic salary of Rs 10 lakh, employed in the private sector. Their own NPS contribution deduction under Schedule XV Paragraph 1(y) is capped at 10 percent of basic, i.e., Rs 1 lakh – but only within the Rs 1.5 lakh Section 123 ceiling. If they have already used up that ceiling through EPF and other investments, the own-contribution deduction in this bucket adds nothing. The actionable stand-alone benefit is the Rs 50,000 under Section 124(3), saving Rs 15,600 in tax at 30 percent. If their private-sector employer contributes 10 percent of their Rs 10 lakh basic (Rs 1 lakh) to NPS, that employer contribution is deductible under Section 124(1)(b), saving the employee Rs 31,200 in tax (since the Rs 1 lakh employer contribution is excluded from taxable salary). The same employee under the new tax regime would get the employer’s NPS contribution at up to 14 percent of basic (Rs 1.4 lakh) deductible under Section 124(2), saving Rs 43,680 – but gets no deduction on their own NPS contributions at all.
Part IIThe Lifetime Tax Saving – the Number People Cite
A 30-Year Career of NPS Contributions
To understand the annuity problem properly, you first need to anchor the tax saving correctly. Let us model three realistic investors: Priya, who earns Rs 12 lakh per year gross under the old regime and contributes Rs 50,000 annually under Section 124(3); Rahul, who earns Rs 25 lakh per year under the new tax regime and whose private-sector employer contributes 14 percent of his Rs 12 lakh basic to NPS (deductible under Section 124(2)); and Meera, who is self-employed, earns Rs 40 lakh gross under the old regime, and maximises both the Schedule XV/Section 123 ceiling (Rs 1.5 lakh, with NPS own-contribution capped at 20% of gross but within this limit) and Section 124(3) (Rs 50,000 additional). All three are assumed to be in the 30 percent bracket. Each career spans 30 years.
| Investor | Tax Regime | Annual NPS Deduction | Tax Saved Per Year (30%) | Total Tax Saved – 30 Years (Nominal) |
|---|---|---|---|---|
| Priya – Rs 12L income, Section 124(3) only | Old | Rs 50,000 | Rs 15,600 | Rs 4,68,000 |
| Rahul – Rs 25L income, employer 14% of Rs 12L basic under Section 124(2) | New | Rs 1,68,000 (employer only) | Rs 52,416 | Rs 15,72,480 |
| Meera – Rs 40L self-employed, Section 123 + Section 124(3) | Old | Rs 2,00,000 | Rs 62,400 | Rs 18,72,000 |
For Rahul, the employer contribution deduction under Section 124(2) of the IT Act 2025 is particularly powerful: over Rs 15 lakh in nominal tax savings across a 30-year career from employer contributions alone, without a single rupee of his own post-tax salary being directed toward NPS for this purpose. Employees under the new regime who do not negotiate their employer’s NPS contribution as part of their CTC structure are leaving a significant statutory benefit unused.
But the number that matters equally – and that almost nobody puts in the same sentence – is what happens to 40 percent of whatever corpus they have accumulated from the day they turn 60.
Part IIIThe Annuity Lock – the Number Nobody Calculates
What the 40 Percent Rule Actually Means
When an NPS Tier I subscriber reaches normal exit age of 60, PFRDA regulations mandate that a minimum of 40 percent of the accumulated corpus must be used to purchase an annuity from a PFRDA-empanelled Annuity Service Provider (ASP). This is not optional, not waivable, and cannot be deferred. The subscriber cannot invest it in mutual funds, fixed deposits, or any other instrument of their choosing. The money goes to the insurance company selected from the approved list, and in return the subscriber receives a monthly pension for life – or for a joint life if a return-of-purchase-price variant is selected.
The remaining 60 percent can be withdrawn as a tax-free lump sum. Under the Income Tax Act 2025, this exemption is provided in Schedule VII, Table Sl. No. 6, which exempts any payment from the National Pension System Trust on closure or opting out of the pension scheme referred to in Section 124, to the extent that it does not exceed 60 percent of the total amount payable at the time of such closure. This is the portion that enjoys EEE treatment – contributed with a deduction, grew tax-free, and exits tax-free. The 40 percent going into the annuity is also not taxed at the moment of corpus transfer to the ASP, by virtue of Section 124(9), which provides that the assessee shall not be deemed to have received any amount in the tax year if such amount is used for purchasing an annuity plan in the same tax year. The tax charge begins only when pension payments flow from the annuity.
Income Tax Act 2025 – Annuity Exit Rules
Schedule VII, Table Sl. No. 6: Exempts up to 60% of the NPS corpus received on closure or opting out of the scheme under Section 124. The 40% directed to the annuity is not taxed at the point of corpus transfer per Section 124(9).
Section 124(6)(b): Pension received from the annuity plan purchased on closure or opting out of NPS is deemed to be the income of the individual in the tax year in which it is received and is charged to tax accordingly.
Section 124(7): Any amount received by the nominee on the death of the assessee under Section 124(6)(a) (i.e., on closure) shall not be deemed to be the income of the nominee – providing a tax-free death benefit on the lump sum portion.
The lump sum corpus transfer to the ASP: Not a taxable receipt per Section 124(9) – only the monthly pension flowing from the annuity is taxed, in the year of receipt.
Section 124(6)(b): Pension received from the annuity plan purchased on closure or opting out of NPS is deemed to be the income of the individual in the tax year in which it is received and is charged to tax accordingly.
Section 124(7): Any amount received by the nominee on the death of the assessee under Section 124(6)(a) (i.e., on closure) shall not be deemed to be the income of the nominee – providing a tax-free death benefit on the lump sum portion.
The lump sum corpus transfer to the ASP: Not a taxable receipt per Section 124(9) – only the monthly pension flowing from the annuity is taxed, in the year of receipt.
What “mandatory” means in practice: There is no exception to the 40 percent annuity rule for normal exit at 60 for corpora above Rs 5 lakh. The only scenario where the full corpus can be withdrawn as a lump sum without purchasing an annuity is if the total accumulated balance at exit is Rs 5 lakh or less.
Annuity Rates: What the Market Is Actually Paying
As of 2025-26, the annuity rates offered by PFRDA-empanelled ASPs range from 5.5 percent to 7.5 percent per annum, depending on the provider, the annuity variant, and the subscriber’s age at purchase. A single life annuity without return of purchase price (the highest-paying option) fetches approximately 7 to 7.5 percent at age 60. A single life annuity with return of purchase price pays approximately 6 to 6.5 percent. A joint life annuity with return of purchase price covers both the subscriber and spouse and pays approximately 5.5 to 6 percent. These rates track prevailing 10-year government securities yields, which traded in the 6.5 to 7 percent range through much of 2025.
The Real Cost: Running the Numbers
| Total NPS Corpus at 60 | 40% Locked in Annuity | Annuity Rate (6.5%) | Gross Monthly Pension | Tax at 30% Slab | Net Monthly Take-Home | Annual Net Pension |
|---|---|---|---|---|---|---|
| Rs 50 lakh | Rs 20 lakh | 6.5% | Rs 10,833 | Rs 3,250 | Rs 7,583 | Rs 90,996 |
| Rs 1 crore | Rs 40 lakh | 6.5% | Rs 21,667 | Rs 6,500 | Rs 15,167 | Rs 1,82,004 |
| Rs 2 crore | Rs 80 lakh | 6.5% | Rs 43,333 | Rs 13,000 | Rs 30,333 | Rs 3,63,996 |
| Rs 3 crore | Rs 1.2 crore | 6.5% | Rs 65,000 | Rs 19,500 | Rs 45,500 | Rs 5,46,000 |
The 30 percent tax applied in the table is illustrative for subscribers with substantial other retirement income. The actual tax on the annuity income depends entirely on total income in each year of retirement. For subscribers whose annuity pension is their only income, the effective tax may be far lower or nil. This is analysed in detail in Part IV.
The Inflation Problem Nobody Mentions
The standard annuity amount is fixed at the time of purchase and does not increase. A Rs 43,333 per month pension at age 60 remains Rs 43,333 at age 75 and at age 85. India’s average CPI inflation over the past 25 years has been approximately 5.8 percent annually. At that rate, the purchasing power of a fixed monthly payment halves in approximately 12 years. The subscriber who retires at 60 and lives to 80 will find that their pension has lost roughly half its real value by age 72.
The inflation math over 20 years: At 5.8% average inflation, Rs 43,333 per month today is worth only approximately Rs 14,100 in real terms at age 80. Fixed annuities solve longevity risk but create compounding inflation risk – the structural weakness of the mandatory NPS annuity as a retirement income engine.
Part IVThe EET Problem – When Your Pension Becomes Taxable Income
NPS Is EET, Not EEE – and the Head of Tax Matters
The 60 percent lump sum from NPS is EEE – contributed with a deduction, grew tax-free, and exits tax-free under Schedule VII, Table Sl. No. 6 of the IT Act 2025. The 40 percent annuity corpus is also deductible at contribution and grows tax-free, and is not taxed at the moment of corpus transfer to the ASP under Section 124(9). But once the annuity begins paying, every monthly pension receipt is a taxable event.
Under the Income Tax Act 2025, the NPS annuity pension is taxed under the head “Salaries.” This is established by Section 16(b), which expressly includes “any annuity or pension” within the definition of “salary” for income tax purposes. Section 124(6)(b) deems the pension received from the annuity plan to be the income of the individual in the year of receipt. The two provisions together place the NPS annuity income squarely under the “Salaries” head, not “Income from Other Sources” as is sometimes stated incorrectly. This distinction has practical implications: income under the Salaries head is eligible for the standard deduction of Rs 75,000 under Section 19(1) read with Schedule III, which reduces the taxable pension income by Rs 75,000 each year – a benefit that does not apply to income classified under “Income from Other Sources.”
Income Tax Act 2025 – How Annuity Pension Is Taxed
Section 16(b): “Salary” includes “any annuity or pension” – placing NPS annuity income under the head “Salaries.”
Section 124(6)(b): Pension received from the annuity plan purchased on closure or opting out of NPS is deemed to be the income of the individual in the tax year in which it is received, charged to tax as income of that year.
Section 19(1) / Schedule III: Standard deduction of Rs 75,000 applies to income under “Salaries” – including NPS annuity pension. This reduces the taxable pension by Rs 75,000 per year.
Section 9329 (TDS): TDS is applicable on annuity payments exceeding Rs 10,000 per year (or such higher amount as may be prescribed), charged as “Salaries” income. The ASP is responsible for TDS deduction.
Section 124(6)(b): Pension received from the annuity plan purchased on closure or opting out of NPS is deemed to be the income of the individual in the tax year in which it is received, charged to tax as income of that year.
Section 19(1) / Schedule III: Standard deduction of Rs 75,000 applies to income under “Salaries” – including NPS annuity pension. This reduces the taxable pension by Rs 75,000 per year.
Section 9329 (TDS): TDS is applicable on annuity payments exceeding Rs 10,000 per year (or such higher amount as may be prescribed), charged as “Salaries” income. The ASP is responsible for TDS deduction.
How Annuity Income Is Taxed in Practice
The NPS annuity pension is assessed each year under the head “Salaries.” After the standard deduction of Rs 75,000, the net pension income is added to the subscriber’s other income for that year – FD interest, rental income, dividend income – and taxed at the applicable slab rate. Under the new tax regime (Section 202(1)), the basic exemption starts at Rs 4 lakh, with a full rebate under Section 156(2) available where total income does not exceed Rs 12 lakh, effectively making income up to Rs 12 lakh tax-free for individuals under the new regime. Under the old tax regime, the rebate under Section 156(1) is available only where total income does not exceed Rs 5 lakh, providing a full rebate up to Rs 12,500 – meaning zero tax for incomes at or below Rs 5 lakh.
A practical illustration – corrected per IT Act 2025: Meera retires at 60 with a total NPS corpus of Rs 2 crore. She withdraws Rs 1.2 crore (60%) tax-free under Schedule VII, Table Sl. No. 6. She invests this in a senior citizen savings scheme and debt mutual funds generating approximately Rs 84,000 per year in taxable interest. She also has Rs 80 lakh going into an annuity at 6.5%, generating Rs 43,333 per month or Rs 5,20,000 per year – taxable under Salaries. After the standard deduction of Rs 75,000, her net pension income assessable is Rs 4,45,000. Adding Rs 84,000 from other investments, her gross taxable income is Rs 5,29,000. Under the old regime, after the basic exemption of Rs 3 lakh for senior citizens (age 60-79), her net taxable income is Rs 2,29,000 – taxed at 5%, giving a tax of approximately Rs 11,450. In this scenario the EET structure works strongly in her favour: she saved tax at 30% on the way in and pays only 5% on the way out. However, if she has a spouse’s pension, rental income, or interest from reinvested lump sum, the stacking of income pushes her into the 20 or 30 percent bracket rapidly, eroding the arbitrage.
Part VNPS vs PPF vs ELSS – An Honest Side-by-Side
| Feature | NPS Tier I | PPF | ELSS |
|---|---|---|---|
| IT Act 2025 provision | Section 123 / Schedule XV Para 1(y) + Section 124(3) + Section 124(1)/(2) | Section 123 / Schedule XV Para 1(d) | Section 123 / Schedule XV Para 1(z) |
| Entry deduction – old regime | Own contribution within Rs 1.5L (Section 123) + Rs 50,000 exclusively (Section 124(3)). Employer contribution at 10% of salary for private, 14% for govt (Section 124(1)). | Up to Rs 1.5L/yr – within Section 123 ceiling | Up to Rs 1.5L/yr – within Section 123 ceiling |
| Entry deduction – new regime | Only employer contribution: 14% of salary for all employers under Section 124(2). Zero deduction on own contributions. | Not available under new regime | Not available under new regime |
| Tax on growth | Nil | Nil | LTCG above Rs 1.25L at 12.5% (Section 198 of IT Act 2025) |
| Lock-in period | Until age 60 for Tier I; no lock-in for Tier II | 15 years (partial withdrawal from year 7) | 3 years per instalment |
| Exit taxation | 60% lump sum tax-free (Schedule VII, Table Sl. No. 6); 40% annuity taxable under Salaries per Section 16(b) and 124(6)(b) | 100% tax-free at maturity – EEE | LTCG above Rs 1.25L at 12.5% per Section 198 |
| Standard deduction benefit at exit | Yes – Rs 75,000/yr on annuity pension under Salaries head | Not applicable | Not applicable |
| Inflation protection at exit | None for standard fixed annuity; escalating annuity option reduces initial payout | Sovereign-set rate, revised quarterly; some inflation linkage historically | Market-linked; equity returns historically inflation-beating over long periods |
| Flexibility at exit | Very low; annuity is irreversible post free-look period | High; full withdrawal at maturity | High; redeem at will after 3-year lock-in |
| Equity exposure | Up to 75% in active choice (reduces to 50% at age 50 under lifecycle fund) | None (sovereign debt) | Minimum 80% in equities by SEBI mandate |
The Opportunity Cost of the Locked 40 Percent
A Rs 80 lakh corpus – the 40 percent annuity portion of a Rs 2 crore NPS corpus – deployed in a systematic withdrawal plan (SWP) from a balanced advantage mutual fund at a conservative 8 percent annualised return would generate approximately Rs 53,333 per month. The NPS annuity at 6.5 percent on the same Rs 80 lakh generates Rs 43,333 per month – 23 percent less. Furthermore, in the SWP structure the capital continues growing and passes to heirs on death. In a plain-life annuity without return of purchase price, the insurance company retains the balance on death. The difference in wealth transfer outcomes over a 20-year retirement is substantial.
The one scenario where the annuity genuinely wins: For a subscriber with no other guaranteed income stream and no dependents, a life annuity with return of purchase price addresses longevity risk and removes the burden of self-managing retirement assets at an advanced age. The NPS annuity is not a trap for this subscriber – the trap is for investors sold NPS primarily as a tax-saving instrument, without a full accounting of what the forced exit looks like.
Part VIWho Should Still Use NPS – and Who Should Think Twice
The Employer Contribution Case – Almost Always a Yes
The employer contribution route under Section 124(1) and 124(2) is among the most efficient tax structures in the Indian salary code. Under the old regime, private-sector employees can have their employer contribute up to 10 percent of basic salary into NPS – excluded from taxable salary entirely, growing tax-free, and exiting 60 percent tax-free. Under the new regime, this limit rises to 14 percent for all employers per Section 124(2). Any salaried individual whose employer is willing to restructure CTC to route contributions into NPS should negotiate this – it is a statutory benefit that functions differently depending on regime, but is valuable under both.
The Section 124(3) Case – Requires Honest Modelling
The Rs 50,000 personal contribution under Section 124(3) (old 80CCD(1B)) is worth taking for old-regime taxpayers in the 30 percent bracket with 15 or more years to retirement. The Rs 15,600 annual tax saving means the effective out-of-pocket cost is Rs 34,400 per year – a 31.2 percent day-one uplift. Invested in the NPS equity fund, which has delivered 12 to 14 percent CAGR over 10-year rolling periods, this compounds substantially. The annuity cost at exit is real but manageable when the horizon is long.
The case weakens for investors within 10 years of retirement: a shorter corpus-building phase means less compounding benefit, the annuity yield (5.5-7.5%) on a smaller corpus locked for a shorter pre-retirement period may not offset the permanent loss of flexibility, and the subscriber is entering precisely the life stage where liquidity has the highest option value.
The New Regime Investor – A Fundamentally Different Calculation
For an investor under the new tax regime with no employer NPS contribution, own contributions to NPS Tier I yield zero deduction. Section 202(2)(a)(xii) of the IT Act 2025 is unambiguous: Chapter VIII deductions (which include Section 124(3)) are excluded under the new regime, except for Sections 124(1), 124(2), and 125(2). In this scenario, PPF and equity mutual funds are almost always more rational choices – they offer flexibility at exit and equal or better tax treatment, without a mandatory 40 percent annuity lock.
Are you salaried with employer NPS contribution available?
If yes: negotiate the maximum employer contribution – 10% of basic under old regime (Section 124(1)(b)), or 14% under new regime (Section 124(2)). This is one of the best statutory tax structures available and works under both regimes.
Are you under the old tax regime with 15+ years to retirement?
If yes: contribute Rs 50,000/yr under Section 124(3). The Rs 15,600 tax saving at 30%, invested in NPS equity, creates a meaningful corpus over a long horizon that outweighs the annuity cost at exit in most scenarios.
Are you under the new regime, or within 10 years of retirement?
If yes: model the annuity cost explicitly. At 6.5% annuity rates, with pension taxed under Salaries (though offset by the Rs 75,000 standard deduction), the net effective yield on the locked 40% can be well below what a self-managed debt or balanced fund delivers with full flexibility.
Will your total retirement income stay below Rs 12 lakh under the new regime?
If yes: the new regime’s Section 156(2) rebate makes income up to Rs 12 lakh tax-free – meaning you saved at 30% during your working years and pay zero tax on the annuity pension in retirement. This is the most favourable NPS outcome. Map your projected retirement income carefully before deciding.
Frequently Asked Questions
No. The 40 percent minimum annuity purchase is a hard regulatory floor set by PFRDA for normal exit at age 60, for accumulated corpora above Rs 5 lakh. The tax exemption under Schedule VII, Table Sl. No. 6 of the Income Tax Act 2025 is itself framed as applying to “not more than 60% of the total amount payable” – confirming the legislative intent that the 40 percent annuity purchase is the baseline minimum. You may choose to purchase more than 40 percent as annuity if you prefer a higher monthly pension, but you cannot go below 40 percent. The only exception is if your total corpus at exit is Rs 5 lakh or less, in which case the full amount can be withdrawn as a lump sum without any annuity purchase.
This depends entirely on the annuity variant chosen at purchase. Under a plain single life annuity without return of purchase price, pension payments stop at death and the insurance company retains the corpus – your nominee receives nothing. Under a single life annuity with return of purchase price (ROP), your nominee receives the full annuity corpus on your death, though the monthly pension during your lifetime was lower. Under a joint life annuity with ROP, your spouse continues to receive the pension after your death, and the original corpus returns to nominees on the survivor’s death. Under Section 124(7) of the IT Act 2025, any amount received by a nominee on the death of the assessee under the closure provisions shall not be deemed to be the income of the nominee – so the nominee’s receipt of the lump sum (under an ROP variant) is not taxable. The annuity variant decision is irreversible after the free-look period (typically 15 days from policy issuance) – it must be made carefully before committing.
No, it is not taxable in that case. The NPS annuity pension is assessed under the head “Salaries” per Section 16(b) of the IT Act 2025, added to your total income, and taxed at the applicable slab rate after the standard deduction of Rs 75,000. However, if your total income including the pension – after the standard deduction – falls below the taxable threshold, no tax is owed. Under the old regime, the basic exemption is Rs 3 lakh for senior citizens (60-79 years) and Rs 5 lakh for super senior citizens (80 and above); the Section 156(1) rebate provides full relief for total incomes up to Rs 5 lakh. Under the new regime, Section 156(2) provides a full rebate where total income does not exceed Rs 12 lakh – making income up to Rs 12 lakh effectively tax-free for individuals under the new regime. A retiree with a small NPS corpus and no other significant income may therefore experience a near-EEE outcome in practice: contributions deducted at 20 or 30 percent, annuity pension effectively untaxed at retirement.
You can exit NPS before age 60 (premature exit), but the annuity requirement is actually more restrictive, not less. On premature exit, 80 percent of the corpus must be used to purchase an annuity – you can only withdraw 20 percent as a lump sum. This 80/20 split makes premature exit a poor financial outcome in almost every scenario. The normal exit at 60 with the 60/40 structure is significantly more favourable. Note that on premature exit, the lump sum amount withdrawn (up to 20%) may not attract the Schedule VII, Table Sl. No. 6 exemption which applies specifically to closure/opting-out at superannuation – subscribers should verify the applicable tax treatment with their nodal office or a tax adviser. If you are a government employee or a subscriber to the Unified Pension Scheme, different rules apply under the specific scheme notifications, including Schedule VII, Table Sl. No. 15 and 16 of the IT Act 2025.
No. Section 202(2)(a)(xii) of the Income Tax Act 2025 expressly states that when computing income under the new tax regime (Section 202(1)), no deduction under Chapter VIII shall be allowed – other than the employer’s NPS contribution under Sections 124(1) and 124(2), the Agniveer scheme deduction under Section 125(2), and the deduction for differently-abled persons under Section 146. Section 124(3) – the Rs 50,000 own-contribution deduction – is not listed as an exception and is therefore unavailable under the new regime. If you are under the new tax regime, only your employer’s NPS contribution (up to 14% of salary, per Section 124(2)) provides a deduction. Contributing your own money to NPS Tier I under the new regime gives you no income tax benefit at entry, while the 40 percent annuity lock at exit still applies in full. The decision to contribute own money to NPS under the new regime must be made purely on the product’s merits as a pension vehicle, not as a tax-saving instrument.
The NPS annuity pension is taxed under the head “Salaries”, not “Income from Other Sources.” This is established by Section 16(b) of the Income Tax Act 2025, which defines “salary” to include “any annuity or pension.” Section 124(6)(b) deems the pension received from the annuity plan to be the income of the individual in the tax year of receipt. Together, these provisions bring the NPS annuity squarely under the Salaries head. This is significant for two reasons: first, the standard deduction of Rs 75,000 under Section 19(1) read with Schedule III applies to Salaries income – reducing the taxable annuity pension by Rs 75,000 annually. Second, TDS on the annuity is deducted by the ASP (the insurance company) as if it were salary TDS, and the subscriber must account for it accordingly in their income tax return each year. Note that this provision in Section 9329 covers TDS on annuity payments – “annuity (not being any annuity taxable under the head Salaries)” – which by exclusion confirms that NPS annuities fall under the Salaries head.
The Benefit Is Real. So Is the Cost. Model Both Before You Decide.
NPS is not a bad product. The employer contribution route under Sections 124(1) and 124(2) of the Income Tax Act 2025 is among the most efficient tax structures in the Indian salary code – money that would have been taken as taxable salary instead enters a pension corpus entirely outside the taxable salary, grows compounding for decades, and exits 60 percent tax-free under Schedule VII, Table Sl. No. 6. The Section 124(3) deduction of Rs 50,000 for own contributions is also genuinely valuable for old-regime taxpayers with long horizons.
But the 40 percent annuity lock is a real and quantifiable cost – not a footnote. The annuity pension, taxed each year under the head “Salaries” per Section 16(b), does get the benefit of the Rs 75,000 standard deduction. But at current annuity rates of 5.5 to 7.5 percent, the fixed nominal payout on the locked portion generates an effective yield that a disciplined self-managed retiree could beat – while retaining full flexibility and leaving capital to heirs.
The right framework is not “NPS or no NPS.” It is: maximise the employer contribution route regardless of regime; take the Section 124(3) deduction if you are in the old regime and have at least 15 years to retirement; build a parallel flexible corpus in PPF and equity mutual funds; and model your retirement income projection under both regimes before committing, because the new regime’s Section 156(2) rebate up to Rs 12 lakh can make the annuity pension effectively tax-free in retirement – transforming NPS from EET to a de facto EEE instrument for subscribers whose total retirement income stays within that band.
Disclaimer: This article is for educational and informational purposes only and does not constitute tax, legal, or investment advice. Readers should consult a SEBI-registered investment adviser and a qualified tax professional before making any decisions. The publisher accepts no liability for decisions made in reliance on information contained herein.
