A recent change in National Pension System (NPS) withdrawal rules has created confusion among subscribers nearing retirement. While the pension regulator has allowed higher lump-sum withdrawals, the income tax law has not yet caught up — and that gap could mean higher tax outgo for retirees.
In December 2025, the Pension Fund Regulatory and Development Authority (PFRDA) amended its rules to allow non-government NPS subscribers to withdraw up to 80% of their retirement corpus as a lump sum, up from the earlier 60%.
Under the old framework, subscribers retiring at the age of 60 had only two options for using their accumulated NPS corpus.
1) Up to 60% lump-sum withdrawal — fully tax-free
At retirement, an NPS subscriber could withdraw up to 60% of the total corpus as a lump sum.
This amount was – completely tax-free, exempt under Section 10(12A) of the Income Tax Act and paid out directly to the subscriber.
This provision was meant to help retirees meet large one-time expenses such as repaying loans, buying a house, funding children’s needs, or building an emergency reserve at retirement.
Importantly, any withdrawal beyond 60% was not allowed earlier, which meant the tax-free benefit was capped and clearly defined.
2) Mandatory 40% annuity purchase — pension for life
The remaining 40% of the NPS corpus had to be compulsorily invested in an annuity plan.
This annuity was purchased from a life insurance company, provided regular pension income — monthly, quarterly, half-yearly or annually and ensured that retirees did not exhaust their savings too early.
The amount used to buy the annuity was not taxed at the time of investment and was allowed as tax-exempt under Section 80CCD(5).
Annuity income was taxable
While the investment into the annuity was tax-free, the pension received from it was fully taxable.
What has changed now in NPS withdrawal rules?
In December 2025, the pension regulator made an important change to NPS rules that affects how much money subscribers can take out at retirement. The PFRDA allowed non-government NPS subscribers to withdraw up to 80% of their total corpus as a lump sum, instead of the earlier 60%.
Is the extra 20% is taxable?
Explaining the issue, CA Dr. Suresh Surana says the problem lies in the mismatch between NPS rules and tax law.
“Despite the changes in the NPS withdrawal rules under PFRDA in December 2025, it is pertinent to note that the Income-tax Act, 1961 has not yet been amended.”
Under the existing tax law, Section 10(12A) clearly caps the exemption.
“Section 10(12A) of the Income Tax Act, 1961 provides that any amount received by a taxpayer from the National Pension System (NPS) Trust on closure of his account or on opting out of the NPS scheme is exempt from tax up to 60% of the total amount payable at the time of such closure or exit.”
“Consequently, the balance 40% of the amount received is taxable in the hands of the taxpayer, subject to the applicable provisions of the Act.”
Dr. Surana points out that even though PFRDA now permits a higher withdrawal, the tax exemption has not expanded.
“Thus, Section 10(12A) currently provides an exemption only in respect of up to 60% of the total amount payable to an employee or subscriber on closure or exit from the National Pension System.”
That means the additional 20% now allowed as lump sum does not automatically become tax-free.
“While the additional 20% lump-sum withdrawal is permissible under the PFRDA regulations, it does not presently fall within the scope of the statutory exemption under section 10(12A).”
Unless the law changes, the tax impact is clear.
“In the absence of a corresponding amendment to the Income-tax Act or a specific clarification from the Central Board of Direct Taxes (CBDT), the additional 20% lump-sum withdrawal would be taxable in the hands of the taxpayer under the applicable slab rates.”
So, until the Finance Ministry amends the law or the Central Board of Direct Taxes issues a clarification, retirees opting for higher lump-sum withdrawals must be prepared for a tax hit.