How NPS account attracts an effective tax of just 12% even at the highest slab

The National Pension System (NPS) is popular as a tax-efficient option for retirement savings. As of FY 2026-27, the scheme allows subscribers to withdraw 60% of their retirement corpus tax-free. The remaining 40% can be used to buy an annuity plan, the income from which is taxable.

The annuity income received from the 40% is taxed as per your income tax slab. For someone in the highest marginal tax bracket of 30%, only the 40% of the NPS corpus is subject to taxation. A rough estimation suggests that the effective tax on this amount could be roughly 12%, which is very close to the long-term capital gains (LTCG) tax rate of 12.5% on equity mutual funds.

The above rough approximation was shared by the PFRDA chairperson Sivasubramanian Ramann during a speech at a media event held in Mumbai in February 2026 and published in the regulator's latest Pension Bulletin.

"This if you were to just multiply a simple maths you will find that even if you are at the highest marginal tax bracket your total tax is 12% which is very close to the whole concept of capital gains tax which is 12.5%. So, we must ensure that in our minds we don't have this arbitrage of this type of asset or this type of investment to be directed because income tax is X, Y or Z," the PFRDA chairperson said.

The effective tax rate for someone in the lower tax slab could also be different. For someone having a total income below ₹12 lakh from all sources, even the annuity income would be fully tax-free under the new tax regime.

Why the effective tax on NPS is 12%

The PFRDA chairperson further said that the whole idea of the government behind the 12% effective NPS tax rate is that there should be no tax arbitrage leading a person to make an investment decision.

"The whole idea of the government has been that there should be no tax arbitrage which is leading us to make investments and that I think is a very fundamental thing that we have arrived at," he said.

Income from mutual funds is treated as capital gains as they invest in capital assets. However, income from a pension account like NPS is not treated as a capital gain. Instead, pension accounts are treated are income accounts.