The NPS decoded: two tiers, four asset classes, one compulsory annuity

The National Pension System is the only retirement product in India that is simultaneously cheaper than a mutual fund, more restrictive than a fixed deposit, and taxed better than either. Those three facts pull in different directions, which is why the NPS is so often described and so rarely understood. Start with the structure, because every other question — the tax break, the annuity, the exit — falls out of it.

Two accounts wearing one name

An NPS subscriber actually holds up to two accounts, and confusing them is the single most common error.

Tier I is the pension account. It is the one that carries the tax deductions, and it is locked until you turn 60. Contributions are irreversible in the ordinary case; partial withdrawals are permitted only after three years, only up to 25% of your own contributions, and only for a listed set of reasons — higher education, marriage, a first home, specified illnesses. This is the account people mean when they say "NPS".

Tier II is an ordinary investment account wearing the NPS's low-cost plumbing. No lock-in, no tax deduction, withdraw any day. It is best understood as a low-fee mutual fund with worse tax treatment than an actual mutual fund, which is why almost nobody should open one deliberately.

Everything below is about Tier I.

The asset classes, and who chooses

Your money is spread across asset classes, each managed by the pension fund manager you nominate:

• E — equity. Capped at 75% of the corpus, and that cap is the reason NPS returns sit below a pure equity fund's over long horizons.
• C — corporate debt. Investment-grade bonds.
• G — government securities. Sovereign paper, the volatility floor.
• A — alternatives. REITs, InvITs, AIF units. Closed: PFRDA merged it into C and E in January 2026, so new accounts choose between the other three.

The same schemes are run by every pension fund manager, and their returns side by side are on the NPS returns page.

You pick the split in one of two ways. Active Choice lets you set the percentages yourself within the caps. Auto Choice runs a glide path that mechanically shifts you out of equity as you age — Aggressive starts at 75% equity and tapers from 35, Moderate at 50%, Conservative at 25%. Auto Choice is a rebalancing discipline you cannot talk yourself out of, which for most people is the point.

The costs are the NPS's genuine edge. Fund management is charged in basis points rather than the expense ratio percentages an equity fund quotes, and on a forty-year horizon that gap compounds into real money — the arithmetic is the same one worked through in what a fund really costs, just running in your favour for once.

The exit is the part people miss

At exit you cannot simply take the money. Under PFRDA's rules in force from 15 December 2025, at least 20% of the corpus must buy an annuity — a monthly income contract from a life insurer — and up to 80% comes to you as a lump sum. Government employees still annuitise at least 40%. A corpus of ₹8 lakh or less can be withdrawn in full.

The tax did not move with the rules. The lump sum is tax-free only up to 60% of the corpus; take the full 80% and the slice above 60% is taxed at your slab. The annuity income is taxed at your slab too, every year, for life.

A normal exit comes at 60, or — for anyone outside government service — after 15 years in the NPS, whichever is earlier. Leave before that and the floor inverts: 80% must go into the annuity, 20% comes back, unless the corpus is ₹5 lakh or less. The NPS calculator applies each floor, so you can see what an early exit actually costs before you plan around one.

The annuity is where most of the disappointment lives, and it deserves its own treatment — what an annuity actually pays works through the rates, the variants and why the compulsion exists at all.

⚠️ NPS caps, withdrawal conditions and annuitisation rules are set by PFRDA and have been revised several times; the tax treatment moves with the Union Budget. Verify the current rules before acting — WealthTicker is not a SEBI-registered investment adviser.

Key takeaway

The NPS is a low-cost, equity-capped, annuity-terminated pension wrapper, and you should judge it on all four of those words at once. Tier I is the only part that matters; the 75% equity cap is what limits its upside; and the compulsory annuity — 20% at a normal exit, 40% for government employees, 80% if you leave early — is the price of the tax break. Whether that trade is worth taking is a separate question, worked through in NPS versus mutual funds.