Big Questions

NPS vs mutual funds: The ideal option for retirement?

They have their own strengths. So, we lay it out for you.

NPS vs mutual funds: The ideal option for retirement?

dhanak हिंदी में भी पढ़ें read-in-hindi

India is currently sitting on a retirement time bomb. As per a survey conducted by Nielsen for PGIM Mutual Fund , 51 per cent of Indians don't have a retirement plan in place. And even if they do, most of their money is either invested in bank FDs (fixed deposits) or in the investment plans of life insurance companies, which are insufficient to meet post-retirement needs.

This is where NPS (National Pension Scheme) and mutual funds step in.

While other investment avenues exist, these two are considered ideal for retirement planning.

With that in mind, let's compare the two to see which is better for you.

NPS: An overview

NPS is the central government's initiative to provide pension benefits to all Indian citizens. It is a defined contribution scheme in which investments will be maintained until retirement.

Upon retirement, the investor can withdraw 60 per cent of the corpus, while the remaining 40 per cent is paid as an annuity. An annuity is a fixed sum of money paid out to the investor at pre-determined intervals. The main objective of an annuity is to provide income in retirement.

Where it invests
It invests up to 75 per cent of the investors' money in equities. Of this usually, 90 per cent of the allocation is directed towards large-cap stocks. The balance 25 per cent is invested in debt.

Based on an equity-debt allocation of 75:25, the 10-year category average return is 12.9 per cent as of April 19, 2024.

Lock-in period
In NPS, the investment remains locked in until 60, with the option to extend the investment period until 75.

That said, investors can make partial withdrawals of up to 25 per cent of the investment after three years.

Mutual funds: In a nutshell

Mutual funds are investment vehicles that pool money from investors.

Where they invest
The money pooled from investors is invested in various asset classes, including equity, debt, commodities, etc.

The 10-year category average returns are as follows:

Type of investment Returns (%)
Large cap  14.7
Mid cap  21
Small cap  23.1
Note: For direct plans as of April 19, 2024

Lock-in period
Except for ELSS (equity-linked savings scheme), which has a lock-in period of three years, mutual funds typically allow you to withdraw your money at any time.

NPS vs mutual funds: Which fares better?

Below is a table that can help you understand better.

NPS Mutual funds
Cost More cost-effective. Expense ratio: Maximum 0.09 per cent. Direct passive funds: 0.03-1 per cent. Direct active funds: 0.5-2.5 per cent.
Taxation Only investment that reduces taxable income by Rs 2 lakh under the old tax regime. To know about the taxation rules under the new regime, click here. There are tax-saving funds that reduce taxable income by Rs 1.5 lakh under the old tax regime. Unfortunately, it has no teeth in the new regime.
Tax upon withdrawal Upon redemption, up to 40 per cent of the redemption amount distributed as an annuity will be subject to taxation. The remaining 60 per cent can be withdrawn and is tax free. Long-term capital gains of up to Rs 1 lakh are tax-exempt, with gains above this threshold taxed at 10 per cent.
Flexibility of withdrawal Quite rigid. It's tough to withdraw money before turning 60.  Excluding ELSS, mutual funds allow withdrawals at any time. 
Risk Returns are relatively stable yet lower, as NPS invests primarily in large-cap stocks.  Though volatile in the short run, equity funds deliver impressive returns over the long run as the risk flattens over time.

The bottom line

Both NPS and mutual funds aim to help investors accumulate a sufficient corpus, helping them fulfil their post-retirement needs.

Compared to mutual funds, NPS is a more low-cost and tax-efficient choice. Further, it is ideal for those who want to adopt a disciplined approach to investing. The restriction to withdraw before the age of 60 is beneficial for investors who easily get tempted to redeem the funds before achieving their financial goals. Yet, when it comes to retirement planning, mutual funds triumph over NPS. Here's why:

  • Equity mutual funds such as flexi-cap funds have the freedom to invest across market capitalisation. This increases the likelihood of getting higher returns through exposure to mid- and small-caps, enabling investors to accumulate a larger corpus upon retirement.
  • Here's how: If you had invested Rs 10,000 every month for 10 years in an average flexi-cap fund (which allocates around 30 per cent to small- and mid-cap stocks), your corpus would be Rs 27.5 lakh as of April 19, 2024 compared to Rs 24.2 lakh, had you invested the same in NPS.
  • Further, given that NPS restricts the equity allocation to 75 per cent, your corpus would have been much lower.

Also read: NPS gets an upgrade

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