NPS explained: tax benefits, withdrawal rules, and how it compares to EPF and PPF

NPS gives three separate tax deductions, and only one of them survives if you have switched to the new tax regime. Your own contribution gets you up to 1.5 lakh rupees combined with your other Section 80C investments, plus an additional 50,000 rupees specifically for NPS, both old regime only. Your employer’s contribution gets a deduction of up to 14 percent of your basic salary, and that one applies under both regimes, which is the actual reason NPS still matters to someone who has moved to the new regime.

The three deductions, and which regime keeps which

Section 80CCD(1) covers your own contribution, within the same overall 1.5 lakh rupee ceiling shared with Section 80C and 80CCC, up to 10 percent of salary for employees or 20 percent of gross total income if you are self-employed. Old regime only.

Section 80CCD(1B) adds a further 50,000 rupees specifically for NPS contributions, on top of the 1.5 lakh ceiling, not counted against it. This is the provision that makes NPS worth considering even after the 80C limit is already used up elsewhere, through PPF or ELSS or insurance. Old regime only, and this 50,000 rupee window is the single biggest reason people who otherwise prefer the new regime still keep an NPS contribution going on the side, in years they expect to switch back or file jointly with a spouse under the old regime.

Section 80CCD(2) covers your employer’s contribution, and this is the one that survives into the new regime. The cap is 14 percent of basic salary for both government and private sector employees. Under the old regime the cap differs by employer type, generally 10 percent of salary for private sector employees and 14 percent for government employees. If your total employer contributions across NPS, EPF and any approved superannuation fund exceed 7.5 lakh rupees in a year, the excess becomes a taxable perquisite, worth knowing if your basic salary is high enough for this to apply.

Tier I and Tier II are not the same account

Tier I is the retirement account. It is what gets the tax deductions above, and it comes with restrictions on withdrawing before age 60. This is the account people mean when they talk about NPS as a retirement product.

Tier II is a separate, voluntary account you can open alongside Tier I, invested through the same fund managers, with no lock-in and no restriction on withdrawal. It gets no tax deduction for money going in. Functionally it behaves more like a flexible investment account that happens to sit inside the NPS infrastructure, useful if you want NPS’s fund management without the retirement lock-in, but not a tax-saving tool.

What happens when you actually exit

At retirement, part of your NPS corpus is payable as a tax-free lump sum, and the remaining portion must be used to buy an annuity, a product that pays you a monthly pension for life, from a PFRDA-registered provider. If your total corpus at exit is small enough, you can take the whole amount as a lump sum without buying any annuity at all.

The specific percentages here are worth checking at the time you actually need them rather than trusting a fixed number now. PFRDA has revised the split for non-government subscribers more than once in recent periods, generally in the direction of allowing a larger lump sum and a smaller mandatory annuity, and the small-corpus threshold that exempts you from the annuity requirement entirely has also moved. Government sector subscribers have generally stayed on a more stable 60 percent lump sum, 40 percent annuity structure throughout these changes. Given how much this has shifted, treat any specific percentage you read, including anywhere else on this page, as a starting point to confirm against PFRDA’s current circular rather than a number to plan around blindly.

The annuity itself is a separate purchase, and the monthly pension it eventually pays is taxable at your regular slab rate, the same as any other income, even though the lump sum and the annuity purchase itself were tax-free.

NPS versus EPF versus PPF

EPF is close to automatic for salaried employees: 12 percent from you, 12 percent from your employer, with part of the employer’s share diverted to a separate pension scheme. Our EPF contribution split and EPF corpus projection cover how that actually adds up. There is no equity exposure and no choice involved, the interest rate is declared annually by EPFO.

PPF is fully self-directed, open to anyone including the self-employed, with a fixed government-declared interest rate and no market exposure at all. It is the simplest and most predictable of the three, and also the slowest growing over the long run, since it carries no equity component. The most common PPF account mistakes are worth reading before you open one.

NPS is the only one of the three where you choose an equity allocation, which means it carries market risk the other two do not, and it is the only one of the three that gives a real deduction under the new tax regime, through the employer contribution route. The tradeoff is the mandatory annuity at exit, a portion of your own money that you do not get to take as a lump sum and instead converts into a monthly pension whether or not that suits your actual retirement plan.

Someone maximising tax efficiency under the old regime, with room left in their 80C limit, generally gains the most from NPS’s extra 50,000 rupee window. Someone who has moved to the new regime gets essentially nothing from their own contribution, and the entire case for staying in NPS rests on whether their employer offers the 80CCD(2) contribution route.

What people get wrong about this

Assuming NPS gives the same deduction regardless of regime. It does not. Two of the three deductions disappear entirely under the new regime, and only the employer-contribution route survives.

Treating the 50,000 rupee 80CCD(1B) deduction as separate money from the 1.5 lakh 80C limit in every sense. It is separate for the purpose of the deduction ceiling, but it still needs to actually be contributed to NPS specifically. Money already going into PPF or ELSS does not count toward it just because room exists.

Not realising Tier II has no tax benefit. People sometimes assume any NPS contribution is deductible. Tier II contributions are not, only Tier I is, which matters if you are contributing to both without checking which account the money actually landed in.

Assuming the lump sum versus annuity split is fixed and universal. It depends on your subscriber category and your corpus size, and it has changed more than once recently for non-government subscribers specifically. Confirm the current rule before you rely on it.

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