New NPS Rules: How Your Retirement Planning Just Got More Attractive

The government has announced a significant change to the National Pension System (NPS) for non-government subscribers, making it more attractive and flexible for retirement planning.

Through a gazette notification issued this week, the requirement to invest 40% of one's NPS corpus in an annuity product at withdrawal has been halved to 20%.

This means if you had built a Rs 20-lakh retirement corpus, you were required to invest Rs 8 lakh (40%) in an annuity product to receive a regular pension. The remaining Rs 12 lakh could be withdrawn as a lump sum, with 60% of the total corpus tax-free and the rest of the annuity invested would be taxable.

Under the new rules, you will now need to invest only Rs 4 lakh (20%) in an annuity product. The remaining 80% can be withdrawn as a lump sum — the tax treatment on this withdrawal would still be unchanged, with 60% tax-free and 20% taxable as per your slab.

Dilshad Billimoria, Managing Director and Chief Financial Planner of Dilzer Consultants termed the move a big boost and a breakthrough, adding that, "This is going to encourage a lot of people to use NPS, especially corporate-based NPS, because it provides a dual benefit."

The withdrawal rules vary based on the size of accumulated corpus at retirement:

Corpus up to Rs 8 lakh: You can withdraw the entire amount as a lump sum without purchasing an annuity. This offers complete liquidity for smaller savers.

Corpus between Rs 8 lakh and Rs 12 lakh: You are allowed to withdraw up to Rs 6 lakh upfront. The balance must be used to buy an annuity with a minimum tenure of six years, ensuring a steady monthly pension stream.

Billimoria clarified the unchanged treatment of tax, adding "the flexibility of withdrawal being improved has resulted in tax planning becoming even more critical."

The tax rules remain unchanged. Of the 80% lump sum withdrawal, 60% of the total corpus is tax-free, and the remaining 20% is taxable as per your income slab.

For example, if your corpus is Rs 20 lakh, Rs 4 lakh goes into an annuity product, and Rs 16 lakh can be withdrawn.

Out of this, Rs 9.6 lakh (60% of Rs 16 lakh) is tax-free and Rs 6.4 lakh (20% of Rs 16 lakh) is taxable.

The biggest criticism of NPS has been its rigidity at exit. The mandatory annuity allocation was seen as restrictive because annuity products often deliver low returns and are fully taxable.

Reducing this requirement to 20% gives retirees more control over their money and improves liquidity.

Billimoria notes that while, for smaller NPS accounts, this change is hands down a win, the lock-in is still a deterrent for some.

Under the revised rules, however, NPS subscribers can now stay invested until the age of 85 unless they opt for an early exit. A normal exit is permitted after completing 15 years of subscription or upon reaching 60 years of age, superannuation, or retirement—whichever occurs first.

One of the most attractive features of NPS is the corporate contribution benefit under Section 80CCD(2), which an employee can make use of alongside their EPF contribution.

Employers can contribute up to 14% of basic plus DA, and this amount is deductible from the employee’s taxable income. Combined with EPF and superannuation, the overall cap is Rs 7 lakh annually.

It benefits both the employer and employee as well. Billimoria explains that for the employer, it’s a deductible expense, and for the employee, the annuity corpus grows every year as salary increases.

With the new flexibility, NPS immediately becomes more appealing for those seeking a disciplined, low-cost retirement plan. But should you opt for it?

The benefits include lower annuity requirements — which translates to more money in-hand — and tax benefits under both the old and new regimes. It also offers equity exposure of up to 75% for more risk-taking younger investors, and the cost is also lower compared to other retirement products.

However, there's still a lock-in, and there's partial taxation on the lump sum withdrawal. You're also not allowed to liquidate you investments outside very specific conditions like a medical emergency, house purchase, child’s marriage.

If you do opt for it, Billimoria advises that since the returns are on par with mutual funds, post-tax and cost-adjusted, one should look at consistency in performance over at least five years when choosing a provider.

Young investors can also opt either for active choice or auto allocation. The auto option adjusts equity and debt exposure based on age, while the active choice allows up to 75% equity allocation. Recently, IPOs, REITs, InvITs, and gold and silver ETFs have been added to the investing mix, and equity limits have been relaxed.