How is money withdrawn from a Voluntary Pension Scheme taxed at or before retirement?

What does the law say?

The Voluntary Pension System (VPS) is dealt with in three places in the Income Tax Ordinance, 2001: section 63 gives a tax credit when you pay in, clause (23A) of Part I of the Second Schedule decides what is exempt when you take money out, and section 12(6) supplies the rate for the part that is not exempt.

Clause (23A) exempts “the accumulated balance upto 50% received from the voluntary pension system offered by a pension fund manager under the Voluntary Pension System Rules, 2005” at the time of the eligible person’s:

• (a) retirement;
• (b) disability rendering him unable to work; or
• (c) death, when received by his nominated survivors.

Its proviso then says that, excluding the disability and death cases, a withdrawal “before retirement age” or a withdrawal “at the time of or after retirement age in excess of fifty percent of the accumulated balance” is charged at the rate specified in section 12(6), and “the pension fund manager shall at the time of making payment deduct tax at the said rate.”

The 50% figure was 25% until the Finance Act, 2009 substituted it, according to the footnote in the consolidated text.

What is the section 12(6) rate?

Section 12(6) sets an average rate based on your own past tax record. The rate is A/B%, where “A is the total tax paid or payable by the employee on the employee’s total taxable income for the three preceding tax years; and B is the employee’s total taxable income for the three preceding tax years.”

In plain terms: add up the tax on your last three years’ taxable income, divide it by the total taxable income of those three years, and apply that percentage to the taxable part of the withdrawal. A person whose tax in the three earlier years was low gets a low rate on the withdrawal.

Section 12(6) is written in terms of an “employee”. Clause (23A) borrows its rate for every VPS withdrawal, including by a self-employed account holder. The text does not explain how the formula is read for someone who was not an employee in those years.

How does it work in practice?

The pension fund manager applies these rules when it pays you. Section 156B, which used to set out the deduction duty separately, was omitted by the Finance Act, 2020, and the duty now sits in the proviso to clause (23A) itself.

Situation	Treatment under clause (23A)
Withdrawal at retirement, up to 50% of the accumulated balance	Exempt
Withdrawal at or after retirement age, the amount above 50%	Taxed at the section 12(6) rate, deducted by the pension fund manager
Withdrawal before retirement age	Taxed at the section 12(6) rate, deducted by the pension fund manager
Disability rendering the person unable to work	Up to 50% exempt; the proviso’s charge does not apply to this case
Death, balance received by nominated survivors	Up to 50% exempt; the proviso’s charge does not apply to this case

One gap is worth knowing. In the disability and death cases the exemption still stops at 50%, but the proviso’s section 12(6) charge is expressly switched off. The clause does not say how an amount above 50% paid in those two cases is taxed, and this page does not guess.

“Retirement age” is not defined in the Ordinance. It comes from the Voluntary Pension System Rules, 2005, which are not part of this corpus.

How does the section 63 credit work on contributions?

Section 63(1) gives an “eligible person” who earns income under the head “Salary” or “Income from Business” a credit for contributions to an approved pension fund. An eligible person, under section 2(19A), is an individual Pakistani holding a valid National Tax Number, CNIC or NICOP.

The credit is computed as (A/B) x C, where A is your tax before credits, B is your taxable income, and C is the lesser of the contribution paid in the year or twenty per cent of your taxable income. The older extra allowance of 2% a year for people joining after age forty applied only up to 30 June 2019.

Worked example (illustrative figures)

Farhan, a retired accountant in Karachi, has Rs. 6,000,000 in his individual pension account when he reaches retirement age. He asks for Rs. 3,600,000 as a lump sum.

1. Exempt limit under clause (23A): 50% x Rs. 6,000,000 = Rs. 3,000,000.
2. Amount above 50%: Rs. 3,600,000 - Rs. 3,000,000 = Rs. 600,000.
3. His last three returns show tax of Rs. 90,000, Rs. 105,000 and Rs. 135,000 = Rs. 330,000 (A), on taxable income of Rs. 2,000,000, Rs. 2,200,000 and Rs. 2,400,000 = Rs. 6,600,000 (B).
4. Section 12(6) rate: 330,000 / 6,600,000 = 5%.
5. Tax the pension fund manager deducts: Rs. 600,000 x 5% = Rs. 30,000.
6. Farhan receives Rs. 3,600,000 - Rs. 30,000 = Rs. 3,570,000.

If Farhan had taken exactly Rs. 3,000,000, no tax would be deducted.

Early withdrawal. Sana, 44, a pharmacist in Lahore, withdraws Rs. 500,000 before retirement age. The whole amount falls under the proviso. If her own section 12(6) rate works out at 4%, the deduction is Rs. 500,000 x 4% = Rs. 20,000.

What if the balance is used for an income payment plan or annuity?

Clause (23B) used to exempt monthly instalments from an income payment plan bought out of the pension account, where the balance was invested for ten years. The Finance Act, 2022 omitted clause (23B). The Ordinance text we hold does not set out a replacement rule for these instalments, so this page does not say how they are now taxed.

Common mistakes

• Treating the whole balance as tax free. Clause (23A) exempts “upto 50%”. The rest is taxable when withdrawn.
• Assuming the charge is at slab rates. The proviso uses the section 12(6) average rate, not the Division I tables.
• Thinking disability or death payouts are taxed like early withdrawals. The proviso expressly excludes sub-clauses (b) and (c).
• Looking for section 156B. It was omitted in 2020; the deduction rule is now in clause (23A).

What to check in the official text

Read clause (23A) and the footnotes on the omitted clause (23B) in Part I of the Second Schedule, section 12(6), section 63 and the definitions in section 2(19A), 2(29B) and 2(40A). Retirement age, disability conditions and income payment plan terms are set by the Voluntary Pension System Rules, 2005, which are outside this corpus.