NPS, the annuity rule and the extra ₹50,000 deduction
What the compulsory annuity actually costs you, why the extra deduction is the strongest argument for the scheme, and how the fund choices work.
Last reviewed · 1,540 words
In short
- At least 40% of the corpus must buy an annuity at retirement. Only the remaining 60% comes out as a tax-free lump sum.
- ₹5,000 a month from 30 to 60 at 10% builds about ₹1.80 crore, of which ₹1.08 crore is withdrawable and ₹71.9 lakh buys a pension of ₹35,930 a month.
- Section 80CCD(1B) gives an extra ₹50,000 deduction above the ₹1.5 lakh of 80C, and it exists only for NPS.
- The employer contribution under 80CCD(2) is deductible in the new tax regime too, up to 14% of basic — the only retirement deduction that survived.
- Annuity income is fully taxable at slab rate, which undoes part of the exemption on the way in.
The National Pension System is a market-linked, low-cost retirement account regulated by the PFRDA. It has the cheapest fund management charges available in India and a compulsory annuity at the end, and the second of those is what the argument about it turns on.
What it builds, and what comes out
₹5,000 a month from age 30 to 60, at 10% returns with a 5% annual increase in contributions:
The corpus grows a month at a time and the contribution steps up once a year:
balance = balance × (1 + annual return ÷ 1200) + monthly contribution
contribution = contribution × (1 + step-up) at each birthday
At retirement the corpus splits: annuity purchase = corpus × annuity share and lump sum = corpus - annuity purchase, with monthly pension = annuity purchase × annuity rate ÷ 12.
| Component | Amount |
|---|---|
| Total invested | ₹39,86,331 |
| Corpus at 60 | ₹1,79,65,105 |
| Lump sum, 60% | ₹1,07,79,063 |
| Annuity purchase, 40% | ₹71,86,042 |
| Monthly pension at 6% | ₹35,930 |
The corpus is four and a half times what was contributed. That part behaves like any other long-horizon equity-weighted investment.
The distinctive part is the split. At least 40% must be used to buy an annuity, and only 60% comes out as cash.
What the annuity rule costs
An annuity converts a lump sum into a guaranteed income for life. Indian annuity rates currently run 5.5% to 7% depending on the option chosen.
₹71,86,042 buying at 6% produces ₹35,930 a month, for life. That is the deal, and its weaknesses are worth stating plainly.
The rate is low. 6% is below what a balanced portfolio would be expected to return, and the insurer keeps the difference along with the mortality risk.
It is usually not inflation-linked. ₹35,930 buys considerably less after twenty years of retirement. Inflation-protected annuities exist and start at a much lower initial rate.
The capital is gone, unless you choose a return-of-purchase-price option — which pays a lower monthly amount, typically 5% rather than 6%, in exchange for returning the principal to your nominee.
The income is fully taxable at your slab rate.
Increasing the annuity share to 60% raises the pension to ₹53,895 a month and reduces the lump sum to ₹71,86,042. Whether that is a good trade depends entirely on whether you would otherwise manage the money well — which is exactly the judgement the mandatory 40% was written to remove.
The deductions, which are the real argument
NPS is the only instrument with a deduction of its own above the crowded ₹1.5 lakh of section 80C.
| Section | Limit | Available in the new regime? |
|---|---|---|
| 80CCD(1) | Within the ₹1.5 lakh of 80C | No |
| 80CCD(1B) | Extra ₹50,000 | No |
| 80CCD(2), employer | 14% of basic | Yes |
80CCD(1B) is worth ₹15,600 of tax a year in the 30% bracket, and it is available to anyone — salaried or self-employed — with no requirement for an employer scheme.
80CCD(2) is the more interesting one. It is the only retirement deduction that survives in the new tax regime, which is now the default. An employer contributing 14% of basic to NPS delivers a deduction that a comparable EPF or 80C contribution no longer does.
For an employee in the new regime, asking the employer to route part of the salary through NPS under 80CCD(2) is one of very few tax levers still available. It requires a salary restructuring rather than a personal decision, and many employers already offer it.
The fund choices
Contributions are split across four asset classes:
| Class | Asset | Cap under Active Choice |
|---|---|---|
| E | Equity | 75% until 50, tapering after |
| C | Corporate bonds | 100% |
| G | Government securities | 100% |
| A | Alternative assets | 5% |
Active Choice lets you set the split yourself, within the equity cap.
Auto Choice follows a lifecycle path that reduces equity with age. Aggressive starts at 75% equity, Moderate at 50%, Conservative at 25%, and each tapers to a bond-heavy allocation by 55.
For a long horizon, the maximum equity allocation is generally the right default, and the tapering handles the sequence-of-returns risk near retirement automatically. Auto Choice Aggressive does this without requiring any decisions.
Fund management charges are 0.03% to 0.09% — an order of magnitude below mutual funds, and the single strongest structural advantage NPS has. Over thirty years, saving a full percentage point of expense ratio is worth roughly a quarter of the final corpus.
You may switch fund managers once a year and change the asset allocation four times, both free.
Tier I and Tier II
Tier I is the retirement account. Deductions apply, withdrawals are restricted, the annuity rule applies at 60.
Tier II is a voluntary savings account with no lock-in and no tax benefit for most subscribers — government employees get a deduction with a three-year lock-in. It is a low-cost investment account rather than a retirement product, and it requires an active Tier I account.
Partial withdrawal from Tier I is allowed after three years, up to 25% of your own contributions (not the employer's, and not the growth), for specified purposes: education, marriage, buying a home, serious illness. Three such withdrawals are permitted in a lifetime.
Exit rules
At 60, at least 40% to annuity and up to 60% as a tax-free lump sum. Where the corpus is ₹5 lakh or less, the whole amount can be withdrawn.
Before 60, at least 80% must go to annuity and only 20% comes out — a much harsher split. Corpuses of ₹2.5 lakh or less can be withdrawn entirely.
Deferral is allowed to 75, either of the withdrawal or of the annuity purchase, and contributions may continue.
On death, the entire corpus goes to the nominee with no annuity requirement and no tax.
The before-60 rule is the practical lock-in. NPS money is not accessible in any meaningful sense until retirement, and that should be assumed when deciding how much to put in.
Against the alternatives
Against EPF. EPF pays a guaranteed 8.25% with no equity risk and no annuity requirement. NPS offers higher expected returns, lower guarantees and a compulsory annuity. Most salaried people will have both.
Against PPF. PPF is fully tax-free at 7.1% with a fifteen-year lock-in and complete flexibility at maturity. NPS has higher expected returns and worse exit terms.
Against a mutual fund SIP. A SIP has no lock-in, no annuity requirement and full control, at 1% to 1.5% of expenses against NPS's 0.09% and without the 80CCD(1B) deduction. Over thirty years the fee difference is large and the flexibility difference is larger.
The honest summary: use NPS for the ₹50,000 deduction and for the employer contribution under 80CCD(2), and be deliberate about anything beyond that. Those two are genuinely valuable. Contributions past them are buying a low-cost fund with a mandatory annuity attached, and whether that is a feature depends on how much you trust yourself with a lump sum at 60.
Choosing the annuity
At retirement you select an annuity provider and a variant, and the choice is permanent. Broadly:
Life annuity. The highest monthly amount, paid until death, nothing to nominees afterwards.
Life annuity with return of purchase price. Roughly one percentage point lower, with the original amount returned to the nominee. This is the most commonly chosen and, on the arithmetic, usually the least efficient — you pay a large ongoing reduction to preserve capital you will not use.
Joint life. Continues to the spouse after death, at a lower rate reflecting the longer expected term. Sensible where a spouse would otherwise have no income.
Annuity increasing at 3% a year. Starts considerably lower and partially addresses inflation. Rarely chosen and frequently the right answer for someone retiring at 60 with a thirty-year horizon.
Rates differ between providers by half a point or more for identical products, and the comparison is available on the NPS Trust portal. Half a point on ₹72 lakh is ₹3,000 a month for life, which makes this the single most valuable hour of research in the whole process.
Practical points on running the account
The PRAN is permanent and portable across employers, cities and sectors. It does not need transferring when you change jobs, which is a real advantage over EPF.
Minimum contributions. ₹1,000 a year in Tier I keeps the account active. Below that it is frozen and reactivation costs a small penalty.
Charges are small but present. A one-time registration fee, a per-transaction charge, and an annual maintenance fee, in addition to the fund management charge. On small contributions the fixed charges are proportionally significant, which makes a few larger contributions cheaper than many tiny ones.
Contribute before 31 March to claim the deduction in that financial year. The 80CCD(1B) allowance does not carry forward.
What this calculator assumes
- Monthly contributions rising at the annual increase you set, compounded at the return you set.
- The corpus is split at the annuity share you choose, with a minimum of 40% at age 60.
- The pension is the annuity purchase amount multiplied by the annuity rate, divided by twelve, with no inflation indexation.
- The lump sum is tax-free; the annuity income is taxable at slab rate and is shown gross.
- Fund management and account maintenance charges are not deducted, and they are small but not zero.