NPS tax benefits

The NPS carries three tax deductions, 80CCD(1), 80CCD(1B) and 80CCD(2), plus a largely tax-free maturity. Only 80CCD(2) survives the new regime.

Updated 10 July 2026 · Reviewed by Salary-Calculator.in

The National Pension System carries three distinct income-tax deductions during the contribution phase, plus a largely tax-free maturity, which together make it close to an exempt-exempt-exempt instrument for the central government employee. The three deductions sit in Sections 80CCD(1), 80CCD(1B) and 80CCD(2) of the Income-tax Act, and the maturity exemptions in Sections 10(12A) and 10(12B). The single most important fact for a serving employee is that of the three deductions, only 80CCD(2), the employer’s share, survives in the new tax regime, and for a government employee that share runs up to 14 per cent of basic pay plus dearness allowance.

This article explains the tax side of the National Pension System , not the scheme mechanics, which the parent article covers. It sets out the three contribution deductions and keeps the employee’s own contribution and the employer’s contribution firmly apart, because they are constantly confused; the way the deductions differ between the old and the new regime; the taxation of the corpus at exit; how the Unified Pension Scheme is treated; the special Tier-II benefit for government employees; and two worked examples. It assumes the reader is a post-2004 recruit on NPS Tier-I.

The three contribution deductions

80CCD(1): the employee’s own contribution

Section 80CCD(1) allows a deduction for the subscriber’s own contribution to the NPS, up to 10 per cent of salary, where salary means basic pay plus dearness allowance and nothing else. The catch is that this deduction sits within the overall Rs. 1,50,000 ceiling of Section 80CCE, which it shares with Section 80C and Section 80CCC. Because the mandatory 10 per cent NPS contribution already competes with life-insurance premiums, children’s tuition, home-loan principal and the rest for that same Rs. 1.5 lakh, an employee often finds 80CCD(1) fully absorbed with no room to spare. It is available in the old regime only.

80CCD(1B): the additional Rs. 50,000

Section 80CCD(1B), introduced by the Finance Act 2015, allows an additional deduction of up to Rs. 50,000 for the subscriber’s own NPS contribution, over and above the Rs. 1.5 lakh ceiling. This is the deduction that makes the employee’s own contribution worthwhile for tax, because nothing else competes for it: the smart move in the old regime is to earmark Rs. 50,000 of the NPS contribution to 80CCD(1B) first, for a clean incremental deduction on top of the Rs. 1.5 lakh basket. It too is available in the old regime only.

80CCD(2): the employer’s contribution

Section 80CCD(2) is different in kind, and it is the important one. It allows a deduction, in the hands of the employee, for the employer’s contribution to the employee’s NPS Tier-I account, over and above the Rs. 1.5 lakh ceiling and over and above the Rs. 50,000 of 80CCD(1B). For a central or state government employee the limit is 14 per cent of salary, again basic pay plus dearness allowance. This 14 per cent has applied to central government employees since the Finance (No. 2) Act 2019, which raised it from 10 per cent, and it is available in both the old and the new regime.

That both-regime availability is the load-bearing point. Because 80CCD(2) covers the employer’s money, not the employee’s, and because it survives in the new regime, it is the one NPS tax benefit that a government employee on the default new regime still gets. A later change, the Finance (No. 2) Act 2024, raised the 80CCD(2) cap to 14 per cent for private-sector and other employees too, but only for those on the new regime; government employees were already at 14 per cent in both regimes, so that change did not alter their position, it merely brought private new-regime employees up to parity. The 14 per cent for government is not a 2024 novelty.

A warning against the commonest error: 80CCD(1) is the employee’s own money, inside the Rs. 1.5 lakh, old regime only; 80CCD(2) is the employer’s money, outside the Rs. 1.5 lakh, both regimes for government. They are not the same deduction and should never be added together as if they were one.

How the regime decides which deductions apply

The whole tax picture reduces to one table.

Deduction	What it covers	Limit (government employee)	Old regime	New regime
80CCD(1)	Own contribution	10 per cent of basic plus DA, within Rs. 1.5 lakh	Yes	No
80CCD(1B)	Additional own	Rs. 50,000, above Rs. 1.5 lakh	Yes	No
80CCD(2)	Employer contribution	14 per cent of basic plus DA, above Rs. 1.5 lakh	Yes	Yes

In the new regime only 80CCD(2), the employer’s 14 per cent, is allowed; 80CCD(1) and 80CCD(1B) are switched off. In the old regime all three stack. Because most central government employees now default to the new regime under Section 115BAC, for the majority the practical NPS tax benefit is the employer’s 14 per cent under 80CCD(2), on top of the Rs. 75,000 standard deduction . Whether the old regime is worth choosing to unlock the other two deductions is the general regime question the old versus new tax regime article works through.

Two worked examples

Take a central government employee whose basic pay plus dearness allowance is Rs. 10,00,000 a year, and see the NPS deduction in each regime.

Deduction	New regime (Rs.)	Old regime (Rs.)
80CCD(1), own 10 per cent	not available	1,00,000 (within the Rs. 1.5 lakh ceiling)
80CCD(1B), additional own	not available	50,000
80CCD(2), employer 14 per cent	1,40,000	1,40,000
NPS-attributable deduction	1,40,000	2,90,000

In the new regime the NPS gives this employee Rs. 1,40,000 of deduction through the employer’s contribution, on top of the Rs. 75,000 standard deduction. In the old regime the full stack is Rs. 2,90,000, though the Rs. 1,00,000 of 80CCD(1) sits inside the Rs. 1.5 lakh ceiling and so competes with any other 80C claims. The old regime therefore unlocks roughly Rs. 1.5 lakh more NPS deduction, but that only pays off if the employee has enough other old-regime deductions, such as home-loan interest and the house rent allowance exemption, to beat the new regime’s lower slabs and its enlarged 80CCD(2). The take-home salary article and the income tax calculator let an employee run their own figures.

The maturity: how the corpus is taxed at exit

The exemptions at the end are what make the NPS close to tax-free overall.

At superannuation, on reaching age 60, up to 60 per cent of the accumulated Tier-I corpus taken as a lump sum is tax-free under Section 10(12A). The remaining minimum 40 per cent is used to buy an annuity, and it is not taxed at the point of purchase; the annuity, or pension, that the employee then receives is taxable as income in the year of receipt. This is the “largely exempt, not fully exempt” point: the corpus comes out tax-free, but the annuity stream it buys is taxed like any pension.

During service, a partial withdrawal is also tax-free within limits. Under Section 10(12B), up to 25 per cent of the subscriber’s own contributions, not of the whole corpus, can be withdrawn tax-free after three years of membership, and only for the purposes the pension regulator permits, such as a serious illness, the higher education or marriage of children, or a first house. The 25 per cent is of the employee’s own contributions, a point often got wrong.

On a premature exit before 60, the withdrawal rules are tighter, with a much smaller lump sum permitted and the larger part compulsorily annuitised, so the lump sum available is well within the 60 per cent that Section 10(12A) exempts. A recent liberalisation by the pension regulator, in late 2025, allows some subscribers to take a larger lump sum of up to 80 per cent at 60; the tax law has not moved with it, so Section 10(12A) still exempts only 60 per cent, and any lump sum between 60 and 80 per cent is taxable at the slab rate. That liberalisation is directed mainly at non-government subscribers, and a government subscriber should confirm how their own exit is treated before relying on it. The exemptions above apply only to Tier-I; Tier-II withdrawals do not get them.

The Unified Pension Scheme

Employees who exercised the one-time option for the Unified Pension Scheme from 1 April 2025 get NPS-equivalent tax treatment. The Central Board of Direct Taxes confirmed, by an Office Memorandum of 2 July 2025, that the tax benefits available under the NPS apply to the Unified Pension Scheme, so the same 80CCD deductions and the same 10(12A) and 10(12B) exemptions carry over. One distinctive point is that the additional 8.5 per cent of basic pay plus dearness allowance that the government contributes to the aggregate pool corpus under the scheme is not treated as the employee’s income, neither salary nor perquisite, and is not taxable. The monthly payout under the scheme is taxable under the head salaries, and the family-pension variant under income from other sources.

Tier-II: a benefit only for government employees

The NPS Tier-II account, the voluntary savings account with free withdrawal, carries no tax benefit for an ordinary subscriber: neither the contributions nor the withdrawals are deductible or exempt. There is one exception, and it is only for central government employees. Under the NPS Tier-II Tax Saver Scheme, 2020, notified by CBDT under Section 80C, a central government employee can claim an 80C deduction of up to Rs. 1.5 lakh, within the 80CCE ceiling, on contributions to a designated Tier-II account, subject to a three-year lock-in. Only central government employees qualify, and because it rides on Section 80C it is an old-regime benefit. Its three-year lock-in is the shortest among the fixed-income 80C options, against five years for a tax-saving bank deposit and the National Savings Certificate and fifteen for the Public Provident Fund.

Common mistakes

A few errors recur, and each costs money or invites a notice.

Adding 80CCD(1) and 80CCD(2) together as a single Rs. 2 lakh figure. They are different deductions on different money: the employee’s own contribution within the Rs. 1.5 lakh ceiling, and the employer’s contribution above it. They are claimed in separate rows of the return.
Claiming 80CCD(1) or 80CCD(1B) in the new regime. Neither is available there; only 80CCD(2) is. An employee on the new regime who claims the Rs. 50,000 of 80CCD(1B) will have it disallowed.
Putting the employee’s own contribution under 80CCD(2). The employer’s contribution goes under 80CCD(2); the employee’s own goes under 80CCD(1) and 80CCD(1B). Reporting the wrong one under 80CCD(2) inflates the deduction and does not match Form 16.
Treating the whole NPS corpus at exit as tax-free. Only up to 60 per cent of the corpus is exempt under Section 10(12A); the annuity the other 40 per cent buys yields a taxable pension.
Reading the 25 per cent partial-withdrawal exemption as 25 per cent of the corpus. It is 25 per cent of the subscriber’s own contributions, not of the whole balance.
Expecting a Tier-II tax benefit as an ordinary subscriber. Only a central government employee gets one, through the Tier-II Tax Saver Scheme with its three-year lock-in, and only in the old regime.

A note on the Income-tax Act, 2025

This article uses the Income-tax Act 1961 section numbers, because they are the numbers every employee, payroll office and Form 16 uses. From the financial year 2026-27 the income is governed by the Income-tax Act, 2025, which comes into force on 1 April 2026 and renumbers these provisions, for example placing the lump-sum exemption at a new-Act clause. The substance of the NPS deductions and exemptions carries over unchanged, so the amounts and the regime rules above hold; only the section numbers migrate.

Frequently asked questions

Which NPS tax deduction is available in the new tax regime?

Only Section 80CCD(2), the deduction for the employer’s contribution. For a government employee that is up to 14 per cent of basic pay plus dearness allowance, and it is over and above the standard deduction. The employee’s own 80CCD(1) and 80CCD(1B) deductions are switched off in the new regime.

How much is the employer NPS deduction for a central government employee?

Up to 14 per cent of basic pay plus dearness allowance, under Section 80CCD(2), available in both the old and the new regime. The 14 per cent for central government employees has applied since the Finance (No. 2) Act 2019, which raised it from 10 per cent.

Can I claim both the Rs. 1.5 lakh 80C and the extra Rs. 50,000 for NPS?

Yes, in the old regime. The Rs. 50,000 additional NPS deduction under Section 80CCD(1B) sits over and above the Rs. 1.5 lakh ceiling of Section 80CCE, so it does not compete with your 80C investments. It is not available in the new regime.

How much of my NPS corpus is tax-free at retirement?

Up to 60 per cent of the accumulated Tier-I corpus taken as a lump sum at superannuation is tax-free under Section 10(12A). The remaining 40 per cent is used to buy an annuity, which is not taxed at purchase, but the annuity pension you then receive is taxable as income.

Does the Unified Pension Scheme get the same tax benefits?

Yes. The tax benefits available under the NPS apply to the Unified Pension Scheme as well, as clarified by the CBDT Office Memorandum of 2 July 2025. The additional 8.5 per cent the government pays into the pool corpus is not treated as the employee’s taxable income.

Do NPS Tier-II contributions save tax?

Not for ordinary subscribers. Only a central government employee can claim an 80C deduction on a Tier-II account, under the NPS Tier-II Tax Saver Scheme, 2020, up to Rs. 1.5 lakh within the 80CCE ceiling and with a 3-year lock-in. It is an old-regime benefit.

External references

References

Income-tax Act, 1961, Sections 80CCD(1) (own contribution, 10 per cent of salary), 80CCD(1B) (additional Rs. 50,000, inserted by the Finance Act 2015) and 80CCD(2) (employer contribution).
Income-tax Act, 1961, Section 80CCE (aggregate deduction ceiling of Rs. 1,50,000 for Sections 80C, 80CCC and 80CCD(1)).
Finance (No. 2) Act 2019 (employer NPS deduction under Section 80CCD(2) raised to 14 per cent for central government employees) and Finance (No. 2) Act 2024 (14 per cent extended to private employees in the new regime).
Income-tax Act, 1961, Sections 10(12A) (up to 60 per cent of the NPS corpus exempt at closure or opting out) and 10(12B) (up to 25 per cent of the subscriber’s own contributions exempt on partial withdrawal).
CBDT Notification No. 45/2020 dated 7 July 2020 (S.O. 2232(E)), the National Pension Scheme Tier-II Tax Saver Scheme, 2020, under Section 80C.
CBDT Office Memorandum dated 2 July 2025 (tax benefits under the NPS apply to the Unified Pension Scheme), and Department of Financial Services Notification No. FS-1/3/2023-PR dated 24 January 2025.
Income-tax Act, 2025 (in force from 1 April 2026), which renumbers the NPS deduction and exemption provisions without changing the substance.