NPS Exit at 60: Why 40% Must Buy an Annuity and 60% Comes as Tax-Free Lump Sum (And the Rs 5 Lakh Full-Withdrawal Exception)

When your National Pension System (NPS) account reaches normal exit at age 60, or on superannuation, a single rule reshapes your entire retirement income plan: under the PFRDA All Citizen Model, a minimum of 40% of the accumulated pension corpus must be used to buy an annuity, and up to 60% can be taken as a lump sum. This 40/60 split is not a guideline you can negotiate around — it is the default settlement mechanism written into the PFRDA (Exits and Withdrawals under NPS) Regulations, 2015. For a subscriber sitting on a Rs 1 crore corpus, that means at least Rs 40,00,000 is locked into a lifelong pension product and Rs 60,00,000 is free to redeploy.

The design decision most retirees get wrong is treating the 60% lump sum as spending money and the 40% annuity as an afterthought. In reality, the tax character of each slice is different, the drawdown flexibility is different, and there is a specific Rs 5 lakh escape hatch that lets small-corpus subscribers skip annuitisation entirely. This guide walks through the exit rules verbatim from the PFRDA framework, the withdrawal tax treatment under the Income-tax Act, and a multi-year worked drawdown so you can decide whether the 60% is better parked in an annuity or run as a systematic withdrawal plan. You can pressure-test the numbers on Oquilia's NPS calculator as you read.

The Scheme Explained

The National Pension System is a defined-contribution scheme regulated by the Pension Fund Regulatory and Development Authority (PFRDA). On reaching superannuation or the normal exit age of 60, a Tier 1 subscriber triggers a settlement that PFRDA calls "normal exit". At that point the accumulated corpus — your own contributions, any employer contributions, and the market-linked returns on both — is split into a compulsory annuity leg and an optional lump-sum leg.

The core rule under the PFRDA All Citizen Model is fixed: a subscriber must use a minimum of 40% of the accumulated pension wealth to purchase an annuity from an empanelled Annuity Service Provider, and may withdraw the balance of up to 60% as a lump sum. You are always free to annuitise more than 40% if you want a larger guaranteed pension — annuitising 50%, 70%, or even 100% is permitted, but you can never annuitise less than 40% on a normal exit at 60.

The single most valuable exception applies to small corpora. If the total accumulated corpus is Rs 5,00,000 or less on the date of exit, the subscriber may withdraw 100% of it as a lump sum, with no compulsory annuitisation at all. This Rs 5 lakh threshold, confirmed in the PFRDA exit FAQs, exists because buying an annuity with a tiny corpus produces a pension too small to be meaningful — a Rs 5 lakh annuity at a 6% assumed rate yields only about Rs 2,500 a month.

PFRDA also allows deferral. A subscriber reaching 60 need not settle immediately: the lump-sum withdrawal can be deferred and the annuity purchase can be deferred, letting the corpus stay invested in the market-linked NPS funds for longer. This is why some retirees with other income keep the NPS corpus compounding past 60 rather than crystallising the 40/60 split on their birthday. The table below summarises how the split behaves across corpus sizes.

Note that these figures assume the statutory minimum 40% annuitisation. A subscriber choosing to annuitise a larger share simply shifts more of the corpus into the pension leg and takes a smaller lump sum.

Tax on Withdrawal

The tax treatment of an NPS exit at 60 is unusually generous, and it is worth separating the three moving parts. First, the lump sum: under Section 10(12A) of the Income-tax Act, the payment received on closure or opting out of NPS is exempt to the extent it does not exceed 60% of the total amount payable. Because the maximum permissible lump sum on normal exit is exactly 60%, the entire lump sum a subscriber can legally take at 60 falls inside this exemption. On a Rs 60,00,000 lump sum from a Rs 1 crore corpus, that is Rs 60,00,000 received tax-free, per incometax.gov.in.

Second, the 40% used to buy the annuity is not taxed at the point of purchase. Moving Rs 40,00,000 from your NPS corpus into an annuity contract is not a taxable event in the year of exit. Instead, the pension the annuity subsequently pays you is taxable in the year of receipt, added to your total income and charged at your applicable slab. Under the FY 2025-26 new regime, income up to Rs 4,00,000 is taxed at 0% and the first slab of 5% begins above Rs 4,00,000, so a retiree whose only income is a modest annuity may pay little or no tax after the Section 87A rebate.

Third, partial withdrawals made before exit follow their own rule. Under Section 10(12B), a partial withdrawal from NPS Tier 1 — permitted up to 25% of the subscriber's own contributions for specified needs such as higher education, marriage, or medical treatment — is exempt from tax. This is separate from the exit settlement and does not consume the 60% lump-sum exemption. The table below sets out the treatment of each leg.

One planning nuance matters for the annuity leg. Because annuity income is fully taxable at slab in every year you receive it, a retiree in a higher bracket effectively pays ongoing tax on the 40% for life. By contrast, if the tax-free 60% lump sum is redeployed into an equity-oriented mutual fund and drawn down as a systematic withdrawal plan (SWP), only the capital-gains portion of each redemption is taxed — and long-term capital gains on equity are taxed at 12.5% only above the Rs 1,25,000 annual exemption. That asymmetry is the crux of the drawdown decision below.

Worked Drawdown

Consider a subscriber, Meera, who retires at 60 in July 2026 with an accumulated NPS corpus of Rs 1,00,00,000. Applying the statutory minimum, she annuitises 40% (Rs 40,00,000) and withdraws 60% (Rs 60,00,000) as a tax-free lump sum under Section 10(12A). The question is what to do with each slice, and the two mainstream routes produce very different income profiles.

The annuity leg. Meera's Rs 40,00,000 buys a lifetime annuity. At an illustrative annuity rate of 6% per annum on a "life annuity without return of purchase price" option, that produces Rs 2,40,000 a year, or Rs 20,000 a month, guaranteed for life. This income is fixed in rupee terms, fully taxable at her slab, and does not adjust for inflation — a real drawback over a 25-year retirement, because Rs 20,000 in 2026 buys far less by 2046. The trade-off is certainty: the annuity cannot run out, whatever markets do. (Annuity rates vary by provider and option; run your own quote before deciding.)

The lump-sum leg via SWP. Meera parks the Rs 60,00,000 in a balanced or equity-oriented fund and runs an SWP of Rs 5,00,000 a year (about Rs 41,600 a month). Assuming an illustrative 8% per annum return, the corpus behaves as shown below. Because she withdraws slightly less than the 8% growth, the capital barely erodes in the early years, and only the gains embedded in each redemption attract long-term capital gains tax at 12.5% above the Rs 1,25,000 exemption.

After five years Meera has drawn Rs 25,00,000 in income yet still holds Rs 58,83,000 in capital, because the 8% assumed growth almost fully replaces the Rs 5,00,000 annual withdrawal. Combined with the Rs 2,40,000 fixed annuity, her total pre-tax retirement income in year one is Rs 7,40,000 — Rs 5,00,000 from the SWP plus Rs 2,40,000 from the annuity. The figures are illustrative: an 8% return is not guaranteed, and a poor market run early in retirement (sequence-of-returns risk) can deplete an SWP faster than the table suggests. Model your own version on the retirement drawdown calculator and compare the two routes side by side using the annuity vs SWP calculator.

The core insight from Meera's plan: the compulsory 40% annuity delivers longevity insurance she cannot outlive, while the tax-free 60% lump sum, run as an SWP, delivers flexibility and better tax efficiency but carries market risk. Most CFPs treat the mandatory 40% as the floor of guaranteed income and the 60% as the growth-and-flexibility bucket, rather than annuitising the whole corpus.

NPS Annuity vs Lump-Sum SWP: Which Wins?

There is no universally correct answer, because the two legs solve different problems. The mandatory 40% annuity solves longevity risk — the danger of living to 95 and running out of money — by paying a guaranteed Rs 20,000 a month for life in Meera's case. The 60% SWP solves inflation and estate risk: it can grow with markets, its withdrawals can be raised over time, and whatever remains passes to heirs, unlike a standard life annuity without return of purchase price, which pays nothing to the estate on death.

Tax efficiency tilts toward the SWP. Annuity income is taxed at full slab every year, whereas an SWP on an equity fund is taxed only on the gain portion at the 12.5% LTCG rate above Rs 1,25,000 a year — often a materially lower effective rate for a retiree with a Rs 60,00,000 pot. That said, the annuity's guarantee has real value for risk-averse retirees, and because PFRDA forces at least 40% into an annuity anyway, the practical question is only whether to annuitise more than the 40% floor. For most subscribers with adequate other assets, sticking to the statutory 40% and keeping the 60% flexible is the balanced choice.

FAQ

Can I withdraw 100% of my NPS corpus at 60?

Only if your total accumulated corpus is Rs 5,00,000 or less on the exit date. Below that threshold, PFRDA allows a full lump-sum withdrawal with no compulsory annuitisation. Above Rs 5,00,000, you must annuitise a minimum of 40% and can withdraw at most 60% as a lump sum.

Is the 60% NPS lump sum really tax-free?

Yes. Under Section 10(12A) of the Income-tax Act, the payment on closure or opting out of NPS is exempt up to 60% of the total amount payable. Since 60% is also the maximum lump sum you can take at normal exit, the entire permissible lump sum is exempt. The annuity income you receive later, however, is taxable at your slab.

Can I annuitise more than 40% if I want a bigger pension?

Yes. The 40% is a statutory minimum, not a ceiling. You can direct 50%, 70%, or up to 100% of the corpus toward an annuity for a larger guaranteed monthly pension. You simply cannot go below 40% on a normal exit at 60.

What happens if I defer my NPS exit past 60?

PFRDA permits deferral of both the lump-sum withdrawal and the annuity purchase. Your corpus stays invested in the market-linked NPS funds and continues to compound. This suits retirees who have other income at 60 and want the NPS pot to grow before they crystallise the 40/60 split.

Is the annuity income from NPS taxed?

Yes. The corpus used to buy the annuity is not taxed at the point of purchase, but the pension the annuity subsequently pays is added to your total income each year and taxed at your applicable slab. Under the FY 2025-26 new regime, income up to Rs 4,00,000 is taxed at 0%, so a modest annuity may attract little or no tax.

Should I take the annuity or run an SWP on the 60%?

You must annuitise at least 40% regardless, so the real choice is what to do with the 60% lump sum. An annuity gives a guaranteed lifelong income taxed at slab; an SWP on an equity fund offers flexibility, potential growth, an estate value, and LTCG taxation at 12.5% above Rs 1,25,000. Model both on Oquilia's annuity vs SWP calculator before deciding.

Can I make partial withdrawals before exiting at 60?

Yes. NPS Tier 1 allows partial withdrawals of up to 25% of your own contributions for specified needs such as higher education, marriage, home purchase, or medical treatment. Under Section 10(12B), such partial withdrawals are tax-exempt and do not reduce the 60% lump-sum exemption available at final exit.