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NISM-Series-X-B: Investment Adviser (Level 2) · Retirement Products

National Pension System (NPS): Tiers, Exit Rules and Tax Benefits

Updated 11 October 2026

The National Pension System is a voluntary, market-linked retirement scheme regulated by PFRDA. You invest through a PRAN account. Tier I is the restricted pension account with tax benefits. Tier II is a flexible savings account. At exit, you must use part of the corpus to buy an annuity. Solve questions by identifying tier, rule and section.

Understand National Pension System (NPS)

The National Pension System (NPS) is a defined-contribution retirement scheme. Your pension depends on what you contribute and how the investments perform. Nobody guarantees a return. The regulator is the Pension Fund Regulatory and Development Authority (PFRDA). NPS started for government employees in 2004 and was opened to all citizens in 2009.

Every subscriber gets a PRAN (Permanent Retirement Account Number). It stays the same if you change jobs or city. The structure has several parties: the NPS Trust, pension funds that invest the money, Central Recordkeeping Agencies (CRAs) that keep records, a trustee bank, a custodian and points of presence that onboard you.

There are two accounts. Tier I is the main pension account. Withdrawals are restricted until exit conditions are met, and it carries the tax benefits. Tier II is voluntary and works like a savings account. You can withdraw at any time, but you need an active Tier I account to open it. Tier II gets no general tax deduction. A tax-saver variant with a 3-year lock-in exists for central government employees.

You choose how money is invested. Under Active Choice you split between E (equity), C (corporate bonds), G (government securities) and sometimes A (alternative assets). For non-government subscribers, equity is capped at 75%. Government sector subscribers face a lower equity cap of 50% under their own scheme. Alternative assets are capped at 5%. Under Auto Choice a life-cycle fund shifts from equity to debt as you age. The options are Aggressive (LC75), Moderate (LC50) and Conservative (LC25). The number is the maximum equity share. The funds reduce equity gradually as the subscriber ages beyond about 35, and PFRDA sets the exact glide path for each option.

At exit, part of the corpus must buy an annuity from a PFRDA-empanelled insurer. The rest can come as a lump sum. The annuity pays your pension, and that income is taxable. The exit rule given in the study material is this: at normal exit at age 60, at least 40% of the corpus must buy an annuity and up to 60% can be taken as a lump sum. On premature exit (before 60), at least 80% must go to an annuity and up to 20% can be taken as a lump sum. Small corpuses can be withdrawn in full, up to a threshold set by PFRDA.

PFRDA has revised its exit rules and thresholds from time to time. So follow your current NISM workbook and the wording of the question. If a question states its own percentage, use that figure.

Key formulas to remember

Equity cap in Active Choice
Equity (E) ≤ 75% of the corpus for non-government subscribers; Alternative assets (A) ≤ 5%
Government sector subscribers have a lower equity cap of 50% under their own scheme. A question offering 100% equity or 10% alternative assets under Active Choice is a trap.
Section 80CCD(1)
Deduction ≤ 10% of salary (basic + DA) for an employee; ≤ 20% of gross total income for a self-employed person
Falls within the overall ₹1,50,000 limit shared with Section 80C. Old regime.
Section 80CCD(1B)
Additional deduction up to ₹50,000
Over and above the ₹1,50,000 limit. Own contributions only. Old regime only.
Section 80CCD(2)
Old regime: employer contribution deduction ≤ 10% of salary (basic + DA), or ≤ 14% for central and state government employees. New regime: ≤ 14% of salary (basic + DA) for all employers
Outside the ₹1,50,000 limit. It is available in both regimes, but the cap differs. The 10% cap for non-government employers applies only in the old regime. Under the new regime the cap is 14% for all employers.
Exit at age 60
Annuity ≥ 40% of corpus; lump sum ≤ 60% of corpus (lump sum = corpus − annuity amount)
This is the rule given in the study material. PFRDA has revised exit rules from time to time, so follow your current workbook and the question stem. If a question gives a different percentage, use the one it gives.
Premature exit (before 60)
Annuity ≥ 80% of corpus; lump sum limited to 20% of corpus
This is the rule given in the study material. Small corpuses can be withdrawn in full, up to a threshold set by PFRDA. Follow your current workbook and the question stem for the exact limit.
Tier I vs Tier II
Tier I: restricted withdrawal, tax benefit. Tier II: free withdrawal, no general tax benefit
Tier II needs an active Tier I account.

How to solve National Pension System (NPS) questions

Most NPS questions test one of four things: structure, tier features, exit and annuity, or tax. Fix the type first, then apply the exact rule.

  1. 1Read the question and identify the type: structure and regulator, tier feature, investment choice, exit, or tax.
  2. 2For structure questions, match the role: PFRDA regulates, NPS Trust holds assets, pension funds invest, CRAs keep records.
  3. 3For tier questions, check withdrawal freedom and tax benefit. Tier I is restricted with benefits. Tier II is flexible without general benefits.
  4. 4For investment questions, apply the caps: equity 75%, alternative assets 5% under Active Choice, and the life-cycle fund names under Auto Choice.
  5. 5For exit questions, note whether it is normal exit at 60 or premature exit. Then apply the stated annuity and lump-sum percentages to the corpus.
  6. 6For tax questions, separate the three sections: 80CCD(1) within ₹1,50,000, 80CCD(1B) extra ₹50,000, 80CCD(2) employer contribution outside the limit.
  7. 7Check the tax regime. Sections 80CCD(1) and 80CCD(1B) apply in the old regime. Section 80CCD(2) applies in both, but the cap differs: 10% of salary (14% for government employees) in the old regime, 14% for all employers in the new regime.
  8. 8Eliminate options that break a cap or mix up two sections.

Quickest way: Three-question filter

When to use it: Use it for fast MCQs where the options look alike.

  1. Ask: who is involved? PFRDA means regulator, not the trust or pension fund.
  2. Ask: which tier or choice? Restricted and taxed means Tier I. Flexible means Tier II.
  3. Ask: which number? Match it to 75%, 5%, ₹50,000, 10%, 14% or the annuity percentage given.
  4. Pick the option where every condition matches. Reject any option with the word guaranteed.

Common mistakes in National Pension System (NPS)

  • Saying NPS gives a guaranteed return.

    You confuse it with PPF or EPF, where rates are set by the government.

    Fix: NPS returns depend on market performance of E, C, G and A. Only the annuity rate is fixed by the insurer at purchase.

  • Treating Tier II as tax-saving for everyone.

    Both tiers are under the same PRAN, so they look similar.

    Fix: Only Tier I contributions qualify for Section 80CCD deductions. Tier II tax-saver for central government employees is the special case.

  • Adding the ₹50,000 under 80CCD(1B) inside the ₹1,50,000 limit.

    You treat all NPS deductions as one bucket.

    Fix: 80CCD(1B) is additional to the ₹1,50,000 limit. 80CCD(2) is separate again.

  • Applying the 10% of salary limit to total income.

    You read 'salary' loosely.

    Fix: For employees, salary means basic plus dearness allowance. Self-employed persons use 20% of gross total income.

  • Using one exit percentage for every question.

    Exit rules differ between normal exit and premature exit, and PFRDA has revised them over time.

    Fix: Use the percentage stated in the question. If it is silent, use the rule in your current workbook: 40% annuity at 60 and 80% annuity on premature exit, as given in the study material. Check the latest PFRDA circular for any revision.

  • Claiming equity can reach 100% under Active Choice.

    You assume customisation is unlimited.

    Fix: Active Choice caps equity at 75% for non-government subscribers (50% for government sector subscribers). Alternative assets are capped at 5%.

Worked examples

Example 1

Rahul, an employee, has basic plus DA of ₹12,00,000. In the old tax regime he contributes ₹1,70,000 to NPS Tier I and has no other Section 80C investments. His employer contributes ₹1,00,000 to NPS. Find the total NPS deduction in the old regime. Then state the employer-contribution deduction if he were in the new regime.

Show the solution
  1. 80CCD(1) limit for an employee = 10% × ₹12,00,000 = ₹1,20,000.
  2. Rahul's own contribution is ₹1,70,000, so ₹1,20,000 goes under 80CCD(1), which is within the ₹1,50,000 overall limit.
  3. The balance is ₹1,70,000 − ₹1,20,000 = ₹50,000. Under 80CCD(1B) the limit is ₹50,000, so the full amount is allowed.
  4. Employer contribution limit under 80CCD(2) for a non-government employer in the old regime = 10% × ₹12,00,000 = ₹1,20,000. The actual ₹1,00,000 is below it, so it is fully allowed.
  5. Old regime total = ₹1,20,000 + ₹50,000 + ₹1,00,000 = ₹2,70,000.
  6. In the new regime, 80CCD(1) and 80CCD(1B) are not available. The 80CCD(2) limit is 14% × ₹12,00,000 = ₹1,68,000. The actual ₹1,00,000 is below it, so ₹1,00,000 is allowed.

Answer: Old regime: total NPS deduction is ₹2,70,000. New regime: only the employer contribution is deductible, which is ₹1,00,000.

Example 2

A non-government subscriber retires at 60 with an NPS corpus of ₹40,00,000. Under the exit rule in the study material, at least 40% of the corpus must buy an annuity. What is the minimum annuity amount and the maximum lump sum? As an illustration only, also show the result if a question stem states a minimum annuity of 20%.

Show the solution
  1. Minimum annuity at 40% = 0.40 × ₹40,00,000 = ₹16,00,000.
  2. Maximum lump sum = ₹40,00,000 − ₹16,00,000 = ₹24,00,000.
  3. Illustration only: if a question stem states 20%, use that figure. Annuity = 0.20 × ₹40,00,000 = ₹8,00,000.
  4. Lump sum then = ₹40,00,000 − ₹8,00,000 = ₹32,00,000.

Answer: At 40%: minimum annuity ₹16,00,000 and maximum lump sum ₹24,00,000. Illustration only, if a question stem states 20%: minimum annuity ₹8,00,000 and maximum lump sum ₹32,00,000. The method is the same for any stated percentage.

Exam tips

  • Memorise the three tax sections as a set: 80CCD(1) with the ₹1,50,000 limit, 80CCD(1B) for ₹50,000 extra, 80CCD(2) for employer contributions.
  • When a question gives an exit percentage, use it. Do not substitute remembered numbers.
  • Watch for traps on guarantees, equity above 75% and Tier II tax benefits.
  • For NPS versus PPF: NPS is market-linked with a mandatory annuity portion; PPF has a government-set rate and a 15-year term. Know the contrast.

Practice questions from Retirement Products

National Pension System (NPS): frequently asked questions

What is the difference between NPS Tier I and Tier II?

Tier I is the mandatory pension account with restricted withdrawals and tax benefits under Section 80CCD. Tier II is a voluntary account that allows withdrawal at any time. You need an active Tier I account to open Tier II.

How does NPS exit and annuity purchase work?

At exit, you must use a prescribed minimum share of the corpus to buy an annuity from an empanelled insurer. You may take the rest as a lump sum. The percentages depend on the exit type and the PFRDA rules in force, so use the figure given in the question.

What is the NPS tax benefit under Section 80CCD(1B)?

It allows an extra deduction of up to ₹50,000 for your own NPS contribution. It is over and above the ₹1,50,000 limit of Section 80CCD(1) with Section 80C. It applies in the old tax regime.

What is the difference between NPS and PPF?

NPS invests in equity, bonds and government securities, so returns vary, and part of the corpus must buy an annuity at exit. PPF pays an interest rate set by the government and has a 15-year term. PPF has an annual contribution cap of ₹1,50,000.