NPS Scheme: Tax Benefits and Deductions Explained

How often does the thought of retirement cross your mind? Probably only when tax season hits. That’s when you wish you had a smart investment that could help you save today and tomorrow. The National Pension Scheme (NPS), a low-risk plan backed by the government, can be one such smart investment for your retirement years, offering benefits including stable returns, flexible investments, and major tax perks. 

In fact, the number of active NPS subscribers hit over 7.8 crore in 2024, a sign that Indians are taking retirement planning seriously. This blog discusses the NPS scheme benefits, which makes it a go-to tax-saving instrument, the types of accounts, who can invest, and how to begin with just a few clicks.

What is the National Pension Scheme?

Introduced by the Government of India in 2004, the National Pension Scheme (NPS) is an elective pension plan regulated by Pension Fund Regulatory and Development Authority (PFRDA). It’s open to Indian citizens aged 18 to 70 years. It encourages disciplined retirement planning. You also get tax relief under Sections 80CCD(1), 80CCD(1B), and 80CCD(2). The scheme serves several key objectives, including:

• Build a substantial corpus for post‑retirement income.
• Provide professionally managed, market-linked returns.
• Encourage long-term financial discipline.

NPS offers two types of accounts:

• Tier I, a mandatory retirement account with withdrawal restrictions and tax benefits.  
• Tier II, a voluntary savings account with flexible withdrawals but no tax deductions.

Additionally, the NPS Vatsalya scheme enables parents or guardians to open an NPS account for minors, offering early savings with tax benefits and automatic Tier I conversion at 18.

Interesting read: VPF vs NPS: Which retirement plan should you choose

NPS eligibility: Key criteria to fulfill

Under the NPS scheme, subscribers have the convenience of choosing between two types of accounts, Tier I and Tier II. 

Feature	Tier I account	Tier II account
Minimum contribution	₹500 per deposit; ₹1,000 yearly minimum, ₹500 minimum contribution at time of account opening	₹250 per deposit; no minimum contribution, ₹1,000 contribution at time of account opening
Lock-in period	Locked until age 60 (extendable to 75)	No lock-in (only available after opening Tier I)
NPS tax exemption	Up to ₹2L deduction: ₹1.5L under 80CCD(1), ₹50k under 80CCD(1B)- Employer contribution is deductible under 80CCD(2)	No tax benefit for private individuals. Tax deduction is only for government employees under Section 80C.
Withdrawals	Allowed partially after 3 years; full withdrawal on retirement or exit	Fully flexible; can withdraw anytime
Who can open	Indian citizens (residents, non resident Indians, overseas citizen of India) aged 18–70	Only those with a Tier I account

NPS tax benefits to know

The NPS Tax Benefits vary by account type and employment:

Tax benefits on self-contribution

• Employees can claim a tax deduction of up to 10% of salary (Basic + DA) under Section 80CCD(1), within the overall ₹1.5 lakh limit under Section 80CCE.
• Additionally, an exclusive deduction of ₹50,000 is allowed under Section 80CCD(1B), over and above the ₹1.5 lakh ceiling.
• Self-employed individuals can claim a deduction of the national pension scheme up to 20% of gross income under Section 80CCD(1), also subject to the overall ₹1.5 lakh limit under Section 80CCE.
• They are also eligible for the extra ₹50,000 deduction under Section 80CCD(1B), beyond the ₹1.5 lakh limit.

Tax benefits on employer contributions 

• As per Section 80CCD(2), employer contributions to the NPS are tax-deductible. Under the old regime, tax deduction was allowed up to 14% of the salary of government employers, and up to 10% for private employers. 

However, effective April 1, 2025, the Finance Act, 2024 has raised the deduction limit for private employers to 14%, aligning it with the limit for government employees. This higher limit is available only under the new tax regime.

Tax benefits on partial withdrawals

• Up to 25% of the self-contribution can be withdrawn tax-free after 3 years for specific purposes such as education or medical expenses, under Section 10(12B) as per PFRDA guidelines.

Tax benefits on annuity purchase

• Tax exemption applies on the purchase of annuity upon attaining 60 years or retirement under Section 80CCD(5).
• However, annuity income received thereafter is taxable under regular income tax rules.

Tax benefits on lump sump withdrawals

• On retirement at 60 years, up to 60% of the accumulated corpus can be withdrawn tax-free under Section 10(12A).
• The remaining 40% must be invested in an annuity, which is taxable when received as income.

Tax benefits for corporate/employers

• Employer contributions made towards employees’ NPS accounts are allowed as a business expense under Section 36(1)(iv)(a).
• This deduction is limited to 10% of the employee’s salary. 

Steps to follow to invest in NPS scheme

Start investing in NPS through these simple steps:

1. Visit a nearby bank or post office (PoP‑SP).
2. Submit the subscriber registration form with PAN/Aadhaar and address proof.
3. Pay minimum ₹500 (Tier I) or ₹1,000 (Tier II).
4. Get your PRAN and welcome kit.
5. Activate your account using IPIN via CRA portal or OTP.

Online (eNPS):

1. Go to the NSDL/Protean eNPS portal.
2. Register with PAN, Aadhaar, mobile, and email; verify via OTP.
3. Select Tier I (mandatory), Tier II (optional), fund manager, and scheme.
4. Make your first payment via UPI or net banking.
5. PRAN and IPIN are generated instantly.

Also explore: Atal Pension Yojana: Achieve your retirement goals with a monthly income

NPS interest rate & withdrawal rules

NPS returns are market-linked and vary based on fund choice. As of 16th June, 2025 the performance of funds is as follows:

Asset class	1-year return (%)	3-year return (%)	5-year return (%)
Equity (Scheme E, Tier I)	15.3 – 18.8	13.1 – 15.7	19.2 – 21.2
Corporate Bonds (Scheme C)	12.5 – 14.5	9.3 – 10.2	9.3 – 10.2
Government Bonds (Scheme G)	12.9 – 14.3	6.7 – 7.1	7.2 – 7.4

NPS provides agility in withdrawals under various scenarios:

• At retirement (age 60+): You may withdraw up to 60% of your Tier I corpus tax-free under Section 10(12A). The residual 40% should be to purchase an annuity, which is taxable when received.
• Partial withdrawals: After 3 years, you can withdraw up to 25% of Tier I contributions tax-free for specific goals like education or emergencies.
• Premature exit (before age 60): Allowed after 10 years. If your corpus is ≤ ₹2.5 lakh, you can withdraw it fully. If more, you may withdraw up to 20%, with the rest mandatorily annuitised.

Tier II funds can be withdrawn anytime, with no restrictions or tax benefits.

Must-know NPS scheme benefits

Apart from the tax benefits associated with NPS scheme, here are the core nps scheme benefits investors should be aware of:

1. Flexibility of contributions

You control how much and how often you invest, with options ranging from ₹250 to ₹500 per contribution based on account type.

2. Better returns

Tier I long-term returns now range from approximately 8% to 10% annually, while Tier II equity-heavy portfolios have delivered up to 28% in the past year.

3. Varying fund options

Subscribers can allocate their investments across equity (up to 75%), government, and corporate bonds. They can also switch fund managers up to four times a year.

4. Fund management by experts

PFRDA-appointed Pension Fund Managers professionally manage your savings, reducing risk through diversification.

5. Choice of annuity

At retirement, you must invest at least 40% of the corpus in annuities, with different payout options for life or joint-life coverage.

6. Affordable structure

With fund management charges capped at around 0.09%, NPS remains one of India’s most cost-effective retirement tools.

Learn more about NPS, give it a read: Facts about NPS and NPS Lite

Conclusion

The NPS scheme benefits go beyond just saving for retirement; they help you cut down taxes, invest flexibly, and build a strong financial future. With the NPS tax exemption available under both regimes, it’s one of the smartest choices for anyone planning ahead. 

Easy to start, low on cost, and rich in long-term value, NPS is a seamless way to grow your savings while reducing your tax bill. A win-win for your present and future.

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