Commutation Rules — How Much Can Be Withdrawn as Lump Sum

What commutation is

Commutation means taking part of a pension as a lump sum instead of as regular income. The pension that continues is smaller, because part of it has been exchanged for cash now.

There is no single commutation rule. The limit depends on where the pension comes from, and two separate questions arise each time: how much the scheme allows to be taken, and how much of that the Income-tax Act exempts.

Central government pension

A central government pensioner covered by the CCS pension rules, the older defined-benefit pension, may commute up to 40% of basic pension under the CCS (Commutation of Pension) Rules, 1981. The commuted part is restored 15 years after commutation, and from then on the pensioner again receives the full pension.

Timing matters. A pensioner who applies within one year of retirement can commute without a medical examination; an application made after one year is allowed only after a medical examination. Central government employees covered by the NPS or the Unified Pension Scheme are not under these rules; their lump sum is governed by those schemes.

Insurer's pension plan and the NPS

On an insurer's individual pension plan, up to 60% of the vesting proceeds may be commuted and the rest must buy an annuity, under IRDAI's Master Circular on Life Insurance Products of 12 June 2024. Older material says one-third.

In the NPS, PFRDA's December 2025 amendment lets a non-government subscriber with a corpus above ₹12 lakh take up to 80% as a lump sum, with at least 20% buying an annuity. Government-sector subscribers remain on the 60/40 rule: up to 60% as a lump sum and at least 40% for an annuity, leaving aside the special rule for small balances.

Income tax on the lump sum

Section 19 of the Income-tax Act, 2025 (old section 10(10A)) deals with commuted pension. For government employees it is fully exempt. A non-government employee who also receives gratuity is exempt on the commuted value of one-third of the full pension; without gratuity the fraction is one-half. Anything commuted beyond that is taxable.

The same section also exempts gratuity and leave encashment at retirement within limits: for a non-government employee the ceilings are ₹20,00,000 and ₹25,00,000 respectively, with formula-based limits applying below them. Gratuity itself is now payable under the Code on Social Security, 2020.

For the NPS, Schedule II of the Act excludes 60% of the corpus. The 80% that PFRDA now permits and the 60% the tax law names are different figures, and the slice between them cannot be assumed to be tax-free.

Rules at a glance

Key points

• Commutation exchanges part of a pension for a lump sum; the continuing pension is smaller.
• A central government pensioner under the CCS pension rules may commute up to 40% of basic pension, restored after 15 years; an application after one year needs a medical examination.
• An insurer's pension plan allows commutation of up to 60% of vesting proceeds.
• In the NPS the lump-sum limit is 80% for non-government subscribers with a corpus above ₹12 lakh and 60% for government subscribers.
• For a non-government employee, the exempt part is the commuted value of one-third of the pension with gratuity, one-half without.

Common misunderstandings

• The 40% limit is not a general rule for all pensions: it applies to central government pensioners under the CCS pension rules.
• One-third is not the amount a non-government employee may commute: it is the fraction of the pension whose commuted value is exempt from tax when gratuity is also received.
• A commuted central government pension is not lost for good: the commuted part is restored after 15 years.
• What a scheme allows as a lump sum and what the tax law exempts are not the same question: in the NPS, Schedule II excludes 60% of the corpus.

Questions people ask