In this article, we list the different options available for withdrawing from NPS after retirement and discuss which is suitable for whom.
Note: The NPS is a mutual fund. Therefore, like any mutual fund, only the NAV on the exit date will apply to existing units to calculate the corpus. So, in the case of deferrals, only the future NAV would apply.
Tax rules are the same for all options. The annuity (NPS corpus used to buy the annuity/pension) is tax-free, but the pension will be taxed as per slab. The remaining amount withdrawn (max allowed 60% of the corpus) is also tax-free.
The National Pension system offers three options to a subscriber at the time of exit (either age 60 for individuals or the age of superannuation for salaried people).
Option 1: Normal exit. Here, the subscriber has to buy an annuity for at least 40% of the accumulated corpus, and the rest can be withdrawn free of tax in one shot.
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Options 2: Extend the time of withdrawal to age 70. The subscriber can continue to invest normally and get tax benefits as usual. This is a smart choice for those who do not need the NPS corpus immediately. An annuity purchased at age 70 will offer a higher interest rate. Also, the total taxable income at age 70 may be lower for some people. See: Higher annuity rates of LIC Jeevan Akshay applicable from Feb 2023
Option 3: This option has different choices, but no further contributions are allowed.
- Choice 1: Defer lump sum payout by a maximum of ten years and annuity payout by three years. After this period, the annuity must be purchased and the lump sum withdrawn.
- Choice 2: Defer only annuity (max three years) or only lump sum payout (max ten years). After this period, the annuity must be purchased and the lump sum withdrawn.
- Choice 3: Phased withdrawal of lump-sum amounts. The lump sum can now be paid systematically on a periodical basis, viz monthly, quarterly, half-yearly or annually for a period until the age of 75 in an automated manner with a one-time request. This must be set up at the time of exit from the NPS.
- Note: The annuity clause (minimum 40%) is still mandatory. This Systematic Lump sum Withdrawal (SLW) only applies to the amount not annuitized. That is, the SLW will only apply to the lump sum portion. Subscribers can either opt for annuity immediately or defer annuity till 75 years.
- During SLW, subscribers can opt for scheme Preference or pension fund manager change. However, it will be applicable only for the lump sum portion. If not withdrawn, the annuity portion (if not purchased) will remain per the existing scheme choice, and no changes can be made.
- Please bear in mind that the corpus is still market-linked. Therfore depending on the market conditions, the corpus may deplete faster because of the continuous withdrawals.
Options 2 and 3 must be exercised at most one year before retirement/exit and at least 15 days before retirement/exit. Although the entire process is online, all this would take time. The exit option should primarily consider personal needs, not tax or prevailing market situation.
Who should choose what?
An immediate annuity makes sense for those with significant employer contributions during their service. This would make NPS the retiree’s dominant fixed-income instrument like yours truly.
If the retiree is confident that she does not need the pension or lump sum money from NPS, extending the withdrawal age to 70 (option 2) may be beneficial. If the retiree needs the annuity (pension) immediately but wants to withdraw the lump sum staggered, option 3 of choice 3 (SLW) may be beneficial. This can offer some protection against market fluctuations.
The SLW is a step in the right direction. It is most useful for retirees who have saved up a large enough corpus to leave the money in NPS and save on tax. If they had to withdraw the lump sum (which is tax-free) and invest it elsewhere, there is a tax incidence upon that withdrawal. With NPS SLW, one can withdraw as necessary and pay no tax. However, this luxury is only possible when one has enough liquid assets elsewhere.
Finally, just because a product offers choices does not mean we have the luxury to choose. Young earners (whether they are part of the NPS or not) should strive to build a basket of retirement products and aggressively invest as much as possible in equity. See: How to build the ideal retirement portfolio.