Section 10(12A)- Tax Exemption on NPS (National Pension System) Withdrawals

Section 10(12A) of the Income Tax Act, 1961 provides important tax benefits for withdrawals from the National Pension System (NPS), India’s voluntary defined contribution pension scheme. This provision specifically deals with the tax treatment of lump sum withdrawals from NPS accounts upon closure or opting out of the scheme.

Key Provisions of Section 10(12A)

Under Section 10(12A), any amount received by an individual from the National Pension System Trust on account of closure or opting out of the scheme is exempt from tax up to 60% of the total amount payable at the time of closure or opting out. The remaining 40% must be used to purchase an annuity plan, which provides regular pension income.

Important features of this exemption:

1. 60% Tax-Free Withdrawal:
   • The most significant benefit is that 60% of the total corpus can be withdrawn completely tax-free at maturity (age 60 or superannuation)
2. 40% Annuity Purchase Requirement:
   • The remaining 40% must be used to purchase an annuity plan from an empanelled Annuity Service Provider (ASP)
3. Minimum Holding Period:
   • To be eligible for this tax exemption, the subscriber must have been part of the NPS for at least 5 years
4. Applicability:
   • This exemption applies to both Tier I and Tier II accounts of NPS
5. Death Benefit:
   • In case of the subscriber’s death, the entire corpus (100%) is paid to the nominee/legal heir and is exempt from tax

Practical Examples of Section 10(12A) Application

Example 1: Standard Retirement Withdrawal

Let’s consider Mr. Sharma who retires at age 60 with an NPS corpus of ₹50 lakh:

• Total Corpus: ₹50,00,000
• Tax-Free Lump Sum Withdrawal (60%): ₹30,00,000 (completely tax-free under Section 10(12A))
• Annuity Purchase (40%): ₹20,00,000 (must be used to buy annuity)
• Tax Treatment: Only the ₹30 lakh withdrawal is tax-exempt. The ₹20 lakh used for annuity purchase isn’t taxed at withdrawal, but the subsequent pension income from the annuity will be taxable as per Mr. Sharma’s income tax slab

Example 2: Premature Withdrawal Before 60 Years

Ms. Patel opts for premature withdrawal at age 55 with an NPS corpus of ₹30 lakh after being in the scheme for 10 years:

• Total Corpus: ₹30,00,000
• Tax-Free Withdrawal (60%): ₹18,00,000
• Annuity Purchase (40%): ₹12,00,000
• Tax Treatment: Same as above – ₹18 lakh tax-free, ₹12 lakh for annuity (pension income taxable)

Example 3: Small Corpus Exception (≤ ₹5 lakh)

If the total corpus is ₹5 lakh or less at maturity:

• Total Corpus: ₹5,00,000
• Option Available: The subscriber can withdraw the entire amount without purchasing any annuity
• Tax Treatment: 60% (₹3 lakh) would still be tax-free, while 40% (₹2 lakh) would be taxable.

Important Considerations

1. Annuity Taxation: While the amount used to purchase annuity is exempt at withdrawal, the regular pension income received from the annuity is taxable as per the subscriber’s income tax slab
2. Partial Withdrawals: Section 10(12A) doesn’t apply to partial withdrawals (which are covered under Section 10(12B)). Partial withdrawals up to 25% of self-contributions are allowed after 3 years for specific purposes like medical emergencies, children’s education/marriage, etc.
3. Tier II Accounts: While Section 10(12A) applies to both Tier I and Tier II accounts, Tier II accounts don’t offer any tax benefits on contributions
4. New vs Old Tax Regime: These NPS benefits are only available under the old tax regime. The new tax regime doesn’t offer these exemptions