Dealing With NPS In 2026 - I : Taxability And Exit Rules

The National Pension System (NPS) is a popular defined contribution plan for retirement. A defined contribution plan is one which allows an individual to periodically invest money into a product throughout their careers. A final lumpsum amount is then redeemed when they retire. NPS is usually a good option for government employees. It is also quite popular among non government subscribers. But, the shortcomings of the NPS mostly outweigh the benefits it offers. And non government subscribers usually invest in the NPS for all the wrong reasons.

There have also been recent regulatory changes to the way the NPS is structured. So we must fully understand how the NPS works before deciding whether it is an optimal fit for us. This is especially true for non government subscribers. Therefore, in today’s post I will give an unbiased account of how the NPS works after the recent changes. This would show who among us should and should not consider investing in the NPS.

How Things Were

When the subscriber turned 60, 60% of the accumulated corpus was paid out as a tax free lumpsum. The remaining 40% was locked into a pension annuity scheme. This would fetch us a fixed rate of interest every year. The annuity income from the pension plan is taxable in our hands. An early exit from the NPS (before age 60) would mean that the components were inverted. A compulsory annuity was to be purchased for 60% of the available corpus. The remaining 40% would be paid out as a tax free lumpsum. I have covered the finer nuances of the old NPS rules in an earlier article The Misunderstood Pension Scheme.

How Things Are Now

On 12th December 2025, the Indian government reduced the mandatory annuity component from 40% to 20%. This very likely means that the tax free lumpsum component will be increased from 60% to 80%. This change is likely to be made official in the upcoming general budget. The maximum age for exit has been increased from 70 to 85. This means subscribers are allowed to defer withdrawals or purchasing the annuity until age 85. They are also allowed to systematically stagger withdrawals. These are welcome changes.

There are also a number of nuances introduced into the exit rules of the NPS. These nuances are primarily based on the :

A. Category of subscriber (Government or non government)

B. Length of contribution and age at exit

C. Accumulated corpus at the time of exit.

Let us now look at each set of nuances in detail.

I. Government Subscriber, Normal Exit (Age 60 Or Later)

If the accumulated corpus at age 60 is Rs 8 lakh or less, the entire amount can be withdrawn as a tax free lumpsum. If the accumulated corpus is worth between Rs 8 lakh and Rs 12 lakh, upto Rs 6 lakh may be withdrawn as a tax free lumpsum. The remaining portion would be the mandatory annuity component. If the accumulated corpus is worth Rs 12 lakh or more, 60% of the corpus may be withdrawn as a tax free lumpsum. The remaining 40% would be the mandatory annuity component. These nuances have been summarised in the graphic that follows.

II. Government Subscriber, Early Exit (Before Age 60)

This is a fairly uncommon scenario. It mainly comes into play on the resignation or termination of a government subscriber. If the value of the corpus is upto Rs 5 lakh, the entire amount can be withdrawn as a tax free lumpsum. If the corpus at exit is worth more than Rs 5 lakh, 80% of the corpus would be the mandatory annuity component. The tax free lumpsum component would be limited to the remaining 20% of the corpus. These nuances have been summarised in the graphic that follows.

III. Non Government Subscriber, Normal Exit (Age 60 Or Later)

Non government subscribers are now required to contribute to NPS for at least 15 years to be eligible for withdrawal benefits. But this does not mean that normal exits are allowed after 15 years of contributing. The age for normal exits remains 60. Non government subscribers are allowed to withdraw upto 80% of the corpus as a tax free lumpsum. Those joining the NPS at age 60 or later may withdraw the entire corpus as a tax free lumpsum. This is allowed when the corpus value at exit is Rs 12 lakh or less. Other exit rules are largely similar to those in Case I (Government Subscriber, Normal Exit). The exit rules pertaining to Case III are summarised below.

IV. Non Government Subscriber, Early Exit (Before Age 60)

The exit rules in such a case are identical to those in Case II ( Government Subscriber, Early Exit).

V. NPS Lite/Swavalambhan And Special Exit Scenarios

NPS Lite and Swavalambhan subscribers are now allowed to withdraw the entire corpus as a tax free lumpsum if the value is Rs 2 lakh or less. Otherwise 60% of the corpus can be withdrawn as a lumpsum. The remaining 40% would form the mandatory annuity component. Subscribers who renounce their Indian citizenship are allowed to withdraw the entire amount as a tax free lumpsum. If a subscriber goes missing, 20% of the corpus is paid out to their family for immediate relief. An FIR and indemnity bond would have to be filed for this. The remaining amount would be paid out only after relevant declaration from the court. These rules have been summarised in the graphic below.

Implications For Investors

The move to increase the lumpsum component to 80% for a normal exit is a welcome move. But this does not change the fact that there is still a mandatory annuity component involved. And the annuity income is still taxable. So there is still some degree of inflexibility involved with the NPS. That is something investors must keep in mind. This just leaves the most important question to be answered.

Who Should Invest?

The NPS in its improved avatar is a great fit for government subscribers. Non government subscribers who are confident of contributing for at least 15 years and working until 60 can also invest. Self employed professionals and those in tenured non government jobs may therefore consider NPS. Most corporate professionals today retire before age 60. It may therefore be unwise for them to consider the NPS. Those who have not opened an NPS account until now may also continue to avoid NPS. There is no compelling reason for them to enter the NPS after these changes.

It would be ideal for all subscribers to consider the NPS as a component of the debt portfolio for long term goals. Equity allocation in the NPS must be avoided. The lifecycle asset allocation choice in the NPS is therefore irrelevant. I may do a separate post on why equity should be avoided within the NPS in the near future. As a parting thought take a look at the exit rules for all categories of subscribers laid out below.