NPS tax benefits

The National Pension System carries three income-tax deductions during the contribution phase and two exclusions at exit, and from 1 April 2026 all five sit in the Income-tax Act, 2025 rather than in the Sections 80CCD and 10(12A) that payroll offices used for twenty years. The deductions are paragraph 1(y) of Schedule XV, read with the Rs. 1,50,000 ceiling in Section 123, for the subscriber’s own contribution; Section 124(3) for a further Rs. 50,000; and Section 124(1)(a) for the employer’s contribution, capped at 14% of salary where the employer is the Central Government or a State Government.

Only one of the three survives the default regime. Section 202(2)(a)(xii) computes new-regime total income without any Chapter VIII deduction except Sections 124(1) and 124(2), Section 125(2) and Section 146, which leaves the employer’s 14% standing and switches off both limbs of the employee’s own contribution. For the central government employee who has not opted out of the default under Section 202(4), the whole NPS tax benefit during service is the employer’s contribution, sitting alongside the Rs. 75,000 standard deduction at serial 2 of the Table in Section 19(1).

At the other end the scheme is close to exempt. Serial 6 of the Table in Schedule II excludes a payment from the National Pension System Trust on closure of the account or on opting out, so far as it does not exceed 60% of the total amount payable at that time, and Section 124(9) keeps the annuitised balance out of charge in the year it buys the annuity. What is taxed is the annuity pension itself, charged under Section 124(6)(b) in the year of receipt at slab rates, which is why the scheme is exempt-exempt-taxed on its income stream and not exempt at every stage.

The scheme mechanics, the exit routes and the regime comparison are in the National Pension System, NPS exit and withdrawal rules and old versus new tax regime articles.

The employee’s own contribution: Schedule XV paragraph 1(y)

The subscriber’s own contribution is deductible up to 10% of salary, and it competes with everything else in the Rs. 1,50,000 basket. Paragraph 1(y) of Schedule XV to the Income-tax Act, 2025 admits a contribution made by an individual to a pension scheme notified by the Central Government to the extent of 10% of salary in the case of an employee, including dearness allowance where the terms of employment so provide but excluding all other allowances and perquisites, or 20% of gross total income in the case of any other individual. Section 123 then allows the aggregate of the sums enumerated in Schedule XV so far as it does not exceed Rs. 1,50,000.

That ceiling is the whole difficulty. A central government NPS subscriber contributes 10% of basic pay plus dearness allowance by rule, not by choice, so the mandatory contribution alone can fill the Rs. 1,50,000 basket and leave nothing for life-insurance premiums, children’s tuition fees, home-loan principal or a five-year post office time deposit, all of which draw on the same Section 123 limit through their own paragraphs of Schedule XV. At Level 13 the mandatory contribution exceeds the ceiling outright.

Paragraph 1(y) is a Chapter VIII route, since Section 123 sits in Chapter VIII, so Section 202(2)(a)(xii) removes it in the new regime. It is an old-regime deduction and nothing else.

The additional Rs. 50,000: Section 124(3)

Section 124(3) is the one deduction that gives the employee’s own money a clean incremental benefit, because it sits outside the Rs. 1,50,000 ceiling. It allows a deduction not exceeding Rs. 50,000 of the amount paid or deposited in the tax year by the individual in an account under a pension scheme notified by the Central Government. There is no salary-linked sub-limit on it, unlike paragraph 1(y): the cap is a flat rupee figure.

The same rupee cannot be counted twice. Section 124(5) provides that no deduction under sub-sections (3) and (4) is allowed for an amount on which a deduction has been claimed and allowed under Section 123, and Section 124(10) states the bar in the other direction. The ordering that follows is mechanical. Earmark Rs. 50,000 of the year’s contribution to Section 124(3) first, then send the balance into the Section 123 basket, which preserves Rs. 50,000 of basket room for other qualifying payments. Reversing the order wastes the exemption where the basket is already full.

Section 124(4) extends the same Rs. 50,000 to a parent or guardian depositing into a minor’s account under the scheme, with the aggregate of the deduction under sub-sections (3) and (4) capped at Rs. 50,000 between them. Like paragraph 1(y), Section 124(3) is in Chapter VIII and is therefore not available under Section 202(1).

The employer’s contribution: Section 124(1)(a)

The employer’s contribution is the key deduction, and it is the only one a new-regime employee keeps. Section 124(1) of the Income-tax Act, 2025 allows the employee a deduction for the whole of the amount contributed by the employer to the employee’s account under a pension scheme notified by the Central Government, so far as it does not exceed 14% of salary where the contributing employer is the Central Government or a State Government under clause (a), and 10% where the employer is anyone else under clause (b). Section 124(2) substitutes 14% for that 10% where the employee’s total income is chargeable under Section 202(1), which is how a private-sector employee on the new regime reaches the government rate.

Nothing in Section 202(2) touches Section 124(1). The exclusion list in Section 202(2)(a)(xii) names Chapter VIII and then carves out Sections 124(1) and 124(2) by name, so the employer’s contribution is deductible on identical terms in both regimes. This deduction is over and above the Rs. 1,50,000 of Section 123 and over and above the Rs. 50,000 of Section 124(3); it is not part of either basket.

The distinction that goes wrong most often is one of ownership rather than arithmetic. Paragraph 1(y) and Section 124(3) deduct the employee’s own money, sit inside or just above the Rs. 1,50,000 ceiling, and vanish in the new regime. Section 124(1) deducts the employer’s money, sits outside both ceilings, and survives. They are separate deductions on separate contributions and are reported in separate rows of the return.

What counts as salary for the 14%

Salary here means basic pay plus dearness allowance and nothing further. Section 124(13)(b) of the Income-tax Act, 2025 defines salary for the purposes of the section as including dearness allowance if the terms of employment so provide, but excluding all other allowances and perquisites. Paragraph 1(y) of Schedule XV carries the same definition in its own words for the 10% limb.

For a central government employee the terms of employment do so provide, so the base is basic pay plus dearness allowance at the rate then in force, which is 60% of basic pay with effect from 1 January 2026 under Department of Expenditure Office Memorandum No. 1/1(i)/2026-E.II(B) dated 22 April 2026. House rent allowance, transport allowance, the tuition and hostel subsidy and every other element of the pay slip stay out of the base. An employee who computes 14% of gross pay rather than 14% of basic pay plus dearness allowance overstates the deduction, and the figure will not agree with the certificate the pay office issues.

Worked arithmetic at two pay levels

The gap between the regimes is the employee’s own contribution, and it is worth between Rs. 86,208 and Rs. 2,00,000 of deduction depending on pay.

Take a Level 7 employee at the entry cell of Rs. 44,900 basic pay, with dearness allowance at 60%. Basic pay plus dearness allowance is Rs. 71,840 a month, or Rs. 8,62,080 a year. The mandatory own contribution at 10% is Rs. 86,208 and the government’s contribution at 14% is Rs. 1,20,691.

Routing the first Rs. 50,000 through Section 124(3) leaves Rs. 1,13,792 of the Section 123 ceiling free for other Schedule XV payments. Doing it the other way round would absorb Rs. 86,208 of the basket and leave the Section 124(3) allowance half unused.

Now take a Level 13 employee at the entry cell of Rs. 1,23,100. Basic pay plus dearness allowance is Rs. 1,96,960 a month, or Rs. 23,63,520 a year, so the own contribution is Rs. 2,36,352 and the government’s is Rs. 3,30,893.

At this level the balance of Rs. 1,86,352 exceeds the Section 123 ceiling, so Rs. 1,50,000 is allowed and Rs. 36,352 falls away, along with any room for other qualifying payments. The old regime is worth Rs. 2,00,000 more in NPS deduction here, and whether that beats the new regime depends on the slab difference and on what other old-regime claims the employee has. The tax regime break-even calculator guide and the income tax calculator run the comparison on actual figures.

When the employer’s contribution becomes a perquisite

An employer contribution large enough to cross Rs. 7,50,000 in a tax year is taxed as a perquisite, and no central government pay level reaches it. Section 17(1)(h) of the Income-tax Act, 2025 brings into perquisite the aggregate amount of any contribution in excess of Rs. 7,50,000 in a tax year made to the account of the assessee by the employer in a recognised provident fund, in the scheme referred to in Section 124(1), and in an approved superannuation fund. Section 17(1)(i) adds the annual accretion by way of interest, dividend or similar amount on the balance attributable to that excess, computed as prescribed.

The threshold in salary terms is Rs. 53,57,143 of basic pay plus dearness allowance a year, which is where 14% equals Rs. 7,50,000. The apex of the pay matrix is Level 18 at a fixed Rs. 2,50,000 a month, or Rs. 4,00,000 a month with dearness allowance at 60%, giving Rs. 48,00,000 a year and an employer contribution of Rs. 6,72,000. A Cabinet Secretary therefore stays under the cap with roughly Rs. 78,000 to spare, and no lower level comes close. The provision matters to a private-sector employee on a large package, not to the central government NPS subscriber.

The perquisite charge is not a regime question. It arrives as salary income under Section 17(1), not as a Chapter VIII deduction, so Section 202(2) does not remove it and it applies identically under both regimes.

Taxation of the corpus at exit

Up to 60% of the corpus leaves tax-free and the annuity that follows is taxed. Serial 6 of the Table in Schedule II to the Income-tax Act, 2025, read with Section 11, excludes any payment from the National Pension System Trust where the payment is on closure of the account of the assessee or on opting out of the pension scheme referred to in Section 124, and the payment does not exceed 60% of the total amount payable at the time of such closure or opting out.

Section 124(6)(a) would otherwise deem the whole amount received on closure or opting out to be income of the year of receipt, and Section 124(6)(b) does the same for the pension received from the annuity plan purchased on that closure. Schedule II serial 6 is the exclusion that cuts the first of those down to 40% of the corpus at most, and Section 124(9) removes the rest by providing that the assessee is not deemed to have received any amount in the tax year if it is used for purchasing an annuity plan in the same tax year. Without Section 124(9) the annuitised balance would be charged once on receipt and again as pension every month afterwards.

What remains chargeable is the annuity stream. The monthly pension from the annuity is income of the year of receipt under Section 124(6)(b), taxed at slab rates, and it carries no dearness relief, unlike a pension under the Old Pension Scheme. Death is treated differently again: Section 124(7) provides that an amount received by the nominee on the death of the assessee, in the circumstances of sub-section (6)(a), is not deemed to be the income of the nominee, and Section 124(8) gives the parent, guardian or nominee of a minor the same treatment where the scheme closes on the minor’s death.

The 60% ceiling in serial 6 has not moved with the regulator, and the gap does not reach a government subscriber. The 80:20 option introduced by the Pension Fund Regulatory and Development Authority in December 2025 applies to the All Citizen model, the corporate sector and those joining after age 60, and leaves the government sector on 60:40 at superannuation. Serial 6 excludes a payment only so far as it does not exceed 60% of the total amount payable, so a non-government subscriber taking the extra 20% in cash is charged on it at slab rates, while a central government employee is capped at 60% by the exit rules in the first place and draws exactly what the serial excludes.

Partial withdrawal during service

A partial withdrawal is excluded up to 25% of the subscriber’s own contributions, not 25% of the corpus. Serial 4 of the Table in Schedule III to the Income-tax Act, 2025, read with Section 11, excludes any payment from the National Pension System Trust under the pension scheme referred to in Section 124, in the hands of any employee or of an assessee being the guardian or parent of a minor, where the payment is on a partial withdrawal made as per the terms and conditions specified under the Pension Fund Regulatory and Development Authority Act, 2013 and the regulations made under it, and the exclusion does not exceed 25% of the amount of contributions made by him.

Two limits therefore run together. The regulator sets when a withdrawal may be made at all, and its permitted purposes were revised in December 2025 to a child’s higher education, a child’s marriage, a first residential house, medical treatment or hospitalisation of the subscriber, spouse, children or parents, disability, and the settlement of a financial obligation taken against a lien on the account. Skill development and starting a business were removed from that list, so a withdrawal taken for either purpose is no longer permissible and cannot qualify. The Act then sets how much of what is drawn stays out of total income. A withdrawal that breaches the regulator’s conditions fails serial 4 on its own terms, because the serial imports those conditions rather than restating them.

Reading the 25% as a share of the accumulated corpus overstates the exempt amount substantially, since the corpus includes the government’s 14% and years of investment return, and serial 4 counts only the contributions made by the subscriber.

The Unified Pension Scheme

A Unified Pension Scheme subscriber draws the same deductions and two exclusions of their own. The Central Board of Direct Taxes placed the scheme on the NPS footing by Office Memorandum dated 2 July 2025, and the Taxation Laws (Amendment) Act, 2025, Act No. 29 of 2025, assented to on 21 August 2025, then wrote the treatment into statute. The Income-tax Act, 2025 carries it forward in its own numbering.

Serial 15 of the Table in Schedule II excludes a payment from the National Pension System Trust received by a subscriber to the Unified Pension Scheme where the payment is received at the time of superannuation, voluntary retirement or retirement under Fundamental Rule 56(j) that is not treated as a penalty under the Central Civil Services (Classification, Control and Appeal) Rules, 1965, and does not exceed 60% of the individual corpus as defined in Department of Financial Services notification F. No. FX-1/3/2024-PR dated 24 January 2025. Serial 16 excludes the lump sum amount as defined in clause (vi) of paragraph 2 of that same notification.

The transfer into the pool corpus is not a receipt. Section 124(11) deems the amount standing to the credit of a Unified Pension Scheme subscriber and received on superannuation, voluntary retirement or Fundamental Rule 56(j) retirement to be income of the year of receipt, and Section 124(12) then provides that the assessee is deemed not to have received any amount where it is transferred from the individual corpus to the pool corpus on any of those events. Section 124(13)(a) takes the meaning of pool corpus and individual corpus from the 24 January 2025 notification rather than defining them afresh.

The government’s additional contribution to the pool corpus, which the scheme sets at 8.5% of basic pay plus dearness allowance, never enters the subscriber’s account and is not credited to the individual corpus, so it is not the employee’s salary or perquisite and is not charged. The monthly assured payout that the scheme delivers on retirement is charged under the head salaries, and the family payout as income from other sources.

Tier-II: a deduction only for central government employees

The Tier-II account carries no tax benefit for an ordinary subscriber and one narrow benefit for a central government employee. Paragraph 1(w) of Schedule XV to the Income-tax Act, 2025 admits a contribution by an employee of the Central Government to an additional account referred to in Section 20(3) of the Pension Fund Regulatory and Development Authority Act, 2013, of the pension scheme notified by the Central Government as referred to in Section 124, for a fixed period of not less than three years, and as per the scheme notified by the Central Government for the purposes of the clause.

Three restrictions travel with it. The subscriber must be a central government employee, so a state government employee, an autonomous body employee and a private-sector subscriber are all outside it. The lock-in is three years, which is shorter than the five years on a tax-saving bank deposit or a National Savings Certificate and shorter than the fifteen-year term of the General Provident Fund, but it is a genuine lock. And because paragraph 1(w) feeds the Section 123 basket, the deduction is capped by the same Rs. 1,50,000 aggregate and disappears in the new regime along with the rest of Chapter VIII.

Tier-II gets none of the exit exclusions either. Serial 6 of the Table in Schedule II and serial 4 of the Table in Schedule III both attach to payments from the National Pension System Trust under the pension scheme referred to in Section 124, on closure, opting out or partial withdrawal, and a Tier-II redemption is none of those. A Tier-II withdrawal is taxed on its gains in the ordinary way.

Claiming the deduction through the pay office

The deductions reach the pay slip through the declaration under Section 392(5)(b) and appear on the annual certificate. Section 392(1) of the Income-tax Act, 2025 requires the person paying salary to deduct tax at the average rate on the estimated income for the year, and Section 392(5)(b) requires that person to obtain from the assessee the evidence, proof or particulars of prescribed claims in the prescribed form before making that estimate. The declaration form is Form No. 124 of the Income-tax Rules, 2026, which replaced Form 12BB of the 1962 Rules.

The employer’s Section 124(1)(a) contribution needs no declaration at all, because the drawing and disbursing officer pays it and already holds the figure. The employee’s own contribution needs one only where the employee wants the old regime and has opted out of the default under Section 202(4). An employee who files no declaration is taxed under Section 202(1) with the standard deduction and the employer’s contribution and nothing else, which for most subscribers is the correct answer anyway.

The certificate has changed name and structure. For the financial year 2025-26 the operative certificate is Form 16 under the repealed 1961 Act. From tax year 2026-27 it is Form 130, prescribed by Rule 215 of the Income-tax Rules, 2026 as the certificate required by Section 395(4) of the Income-tax Act, 2025. A deduction claimed in the return that does not appear on the certificate invites a mismatch notice, so the figures should be reconciled before filing.

Old Act to new Act: the section map

Every NPS provision moved on 1 April 2026, and none of the limits moved with it. Section 536(1) of the Income-tax Act, 2025 repealed the Income-tax Act, 1961, and the Income-tax Act, 2025 redistributed the NPS provisions across a section, a schedule of qualifying payments and two schedules of exclusions.

The 1961 numbers are not dead letters. The financial year 2025-26 return is assessed under the repealed Act by force of the saving in Section 536(2), so a return filed in 2026 for that year still cites Section 80CCD. The 2025 Act numbering governs the financial year 2026-27 onward. Note also that the 2025 Act is not the text assented to on 21 August 2025: the Finance Act, 2026 amended it through 95 clauses of Chapter III Part B with effect from 1 April 2026, and Section 202 is among the sections it touched.

Common mistakes

Six errors recur, and each either costs a deduction or produces a mismatch with the certificate.

• Adding the own contribution and the employer contribution into one figure. They are different deductions on different money, under Schedule XV paragraph 1(y) and Section 124(1) respectively, with different ceilings and different regime treatment, and they occupy separate rows of the return.
• Claiming paragraph 1(y) or Section 124(3) under the new regime. Section 202(2)(a)(xii) removes both. Only Sections 124(1) and 124(2) survive, along with Section 125(2) and Section 146.
• Computing 14% on gross pay. Section 124(13)(b) restricts salary to basic pay plus dearness allowance and excludes all other allowances and perquisites, so house rent allowance and transport allowance are outside the base.
• Claiming Rs. 50,000 under Section 124(3) on an amount already allowed under Section 123. Section 124(5) disallows it and Section 124(10) disallows the reverse. Earmark the Rs. 50,000 first.
• Treating the whole corpus at exit as exempt. Serial 6 of the Table in Schedule II excludes not more than 60% of the total amount payable, and the annuity the balance buys is charged under Section 124(6)(b) every year it is received.
• Reading the partial-withdrawal exclusion as 25% of the corpus. Serial 4 of the Table in Schedule III caps it at 25% of the contributions made by the subscriber, which excludes the government’s share and all accumulated return.

Related Articles

• National Pension System
• NPS exit and withdrawal rules
• Deductions allowed in the new tax regime
• Income-tax Act 2025
• Section 80CCD(1B), the additional NPS deduction
• Unified Pension Scheme
• NPS versus OPS versus UPS
• Old Pension Scheme
• Old versus new tax regime
• New tax regime
• Old tax regime
• Section 115BAC and the default new regime
• Income tax slabs for AY 2027-28
• Standard deduction
• Section 87A rebate
• Section 80C
• TDS on salary
• Form 16
• How to switch tax regime
• Income tax for government employees
• Income tax for pensioners
• Take-home salary for central government employees
• Central government pension
• Family pension
• Gratuity under the NPS Rules 2021
• General Provident Fund
• Commutation of pension
• Pension Fund Regulatory and Development Authority
• CCS (Implementation of NPS) Rules
• Dearness allowance
• Basic pay
• House-rent allowance
• Transport allowance
• Cabinet Secretary pay
• Central Board of Direct Taxes
• 7th Central Pay Commission
• Advance tax
• Tax regime break-even calculator guide
• Income tax calculator
• 7th CPC salary calculator

External references

• Income Tax Department
• Pension Fund Regulatory and Development Authority
• National Pension System Trust
• Department of Financial Services
• Department of Expenditure
• Central Pension Accounting Office

References

1. Income-tax Act, 2025 (Act No. 30 of 2025), in force from 1 April 2026, Section 536(1) repealing the Income-tax Act, 1961: Section 123 (aggregate deduction of Rs. 1,50,000 for the sums enumerated in Schedule XV) and Schedule XV paragraph 1(y) (contribution to a notified pension scheme, 10% of salary for an employee, 20% of gross total income otherwise).
2. Income-tax Act, 2025, Section 124: sub-section (1)(a) employer contribution at 14% for a Central or State Government employer, (1)(b) 10% for other employers, (2) 14% for other employers where the employee is taxed under Section 202(1), (3) additional Rs. 50,000, (5) and (10) the bar on double counting with Section 123, (6) charge on closure and on annuity pension, (7) and (8) receipt by a nominee, (9) annuity purchase not treated as a receipt, (11) and (12) the Unified Pension Scheme pool corpus, (13)(b) definition of salary.
3. Income-tax Act, 2025, Section 202(1) (default regime and its rate table) and Section 202(2)(a)(xii) (Chapter VIII disallowed other than Sections 124(1), 124(2), 125(2) and 146), with Section 19(1) Table serial 2 (standard deduction of Rs. 75,000 where tax is computed under Section 202(1)).
4. Income-tax Act, 2025, Section 17(1)(h) (employer contributions to a recognised provident fund, the Section 124(1) scheme and an approved superannuation fund in excess of Rs. 7,50,000 in aggregate treated as a perquisite) and Section 17(1)(i) (annual accretion on that excess).
5. Income-tax Act, 2025, Schedule II Table serial 6 read with Section 11 (payment from the National Pension System Trust on closure or opting out, excluded up to 60% of the total amount payable), serials 15 and 16 (Unified Pension Scheme final withdrawal and lump sum), and Schedule III Table serial 4 read with Section 11 (partial withdrawal, excluded up to 25% of the subscriber’s own contributions).
6. Income-tax Act, 2025, Schedule XV paragraph 1(w) (contribution by a Central Government employee to the additional account under Section 20(3) of the Pension Fund Regulatory and Development Authority Act, 2013, for a fixed period of not less than three years).
7. Department of Financial Services notification F. No. FX-1/3/2024-PR dated 24 January 2025 (Unified Pension Scheme, defining individual corpus, pool corpus and the lump sum amount at clause (vi) of paragraph 2), and Central Board of Direct Taxes Office Memorandum dated 2 July 2025 (NPS tax benefits applied to the Unified Pension Scheme).
8. Taxation Laws (Amendment) Act, 2025 (Act No. 29 of 2025), assented to on 21 August 2025, which inserted Sections 10(12AA), 10(12AB) and 80CCD(3A) into the Income-tax Act, 1961 before that Act was repealed.
9. Income-tax Act, 2025, Section 392(1) and Section 392(5)(b) (deduction of tax from salary and the evidence of prescribed claims) and Section 395(4) read with Rule 215 of the Income-tax Rules, 2026, notified by CBDT Notification No. 22/2026, G.S.R. 198(E), dated 20 March 2026 (Form 130, replacing Form 16).
10. Department of Expenditure Office Memorandum No. 1/1(i)/2026-E.II(B) dated 22 April 2026 (dearness allowance at 60% of basic pay with effect from 1 January 2026).