How to withdraw from NPS by optimising tax and market fluctuations after 60

Published: September 25, 2021 at 8:17 am

Last Updated on December 29, 2021 at 6:24 pm

Mani asks, “Assume I have 10L in my corpus at the retirement age of 60 based on some NAV value of X. By the time I reach 60, assume there was a market crash and NAV for NPS has fallen drastically by 20%. So I choose the deferment option. After 3 yrs, the market is back to normal and if I chose to withdraw, will the NAV on that day will be used to calculate NPS total amount or will the NAV (X) as on the date at which I chose the deferred option be used to calculate the NPS total amount?”

“After going through all your blogs, there is still much-hidden information on NPS withdrawal. Can you write a blog detailing how to plan the NPS withdrawal so that we can avoid tax and also manage the market fluctuations?”

The National Pension system offers three options to a subscriber at the time of exit (either age 60 for individuals or age of superannuation for those who are salaried).

The NPS is a mutual fund. Therefore like, any mutual fund, only the NAV on the date of exit will apply to existing units for the calculation of the corpus. So in the case of deferrals, only the future NAV would apply.

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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 Here the subscriber has to buy an annuity for at least 40% of the accumulated corpus and the rest can be withdrawn free of tax.

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 for some people, the total taxable income at age 70 may be lower.

Option 3:  This option has different choices but no further contributions are allowed.

  • Choice 1:  Defer both lump sum payout by max 10 years and annuity payout by max 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 After this period, the annuity must be purchased and the lump sum withdrawn.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 10 years). After this period, the annuity must be purchased and the lump sum withdrawn.
  • Choice 3:  Phased withdrawal of lump-sum amount up to the age of 70 with a minimum withdrawal of 10% each year.  The catch here, the annuity will have to be purchased immediately.

Note: The phased withdrawal (choice 3) has been mentioned on the NPS CRA website but cannot be found in their demo slideshows. A screenshot from the demo is shown below.

Withdrawal options from National Pension Scheme shown with a screenshot from NSDL e-Governance Infrastructure Limited the Central Recordkeeping Agency For National Pension System
Withdrawal options from National Pension System shown with a screenshot from NSDL e-Governance Infrastructure Limited the Central Recordkeeping Agency For National Pension System

For selecting option 2, one must choose “I want to contribute in the deferment period”. This will automatically defer both annuity and the lump sum to age 70. Options to defer with contributions for a lesser period are not available! It is possible that such options can be exercised while intimating the NPS POP. What about E-NPS? There is no clarity on this.

To defer only the annuity or lump sum or both without contributions, the corresponding checkboxes should be selected. When chosen, the lump sum will be deferred by 10 years and the annuity by three years. The staggered withdrawal option and lower duration deferral options are not seen, though available! Perhaps this can be arranged with the POP? What about E-NPS? Again clarity is required.

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 to process. The exit option should primarily take into account personal needs and not tax or prevailing market situation.

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 would like to withdraw the lump sum in a staggered manner, then option 3 of choice 3 may be beneficial.  This can offer some protection against market fluctuations. Anyway, the withdrawals are tax-free.

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.

Extending annuity alone by three years  (without contributions) may not be of significant use to retiree’s unless their main income will stop or reduce after three years.

Much better control of the market fluctuations can be obtained by carefully deciding NPS allocation. We have already shown why we should avoid equity (scheme E) in your NPS portfolio. A portfolio mix of gilt (G) and corporate bonds (C) can be quite rewarding in the long term.

Subscribers worried about credit risks can avoid corporate bonds and simply choose gilts. See for example: After 11 years of investing in the NPS (15% equity + 85% bonds) my return is 10%

Gilts or corporate bonds are also volatile (albeit not as much as stocks) and a staggered withdrawal (choice 3 of option 3) can offer a neat way to fight way inflation after retirement.

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 invest as much as possible aggressively in equity. See:  How to build the ideal retirement portfolio

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