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Secrets Yours Investor Guide Never Told You About Mutual Funds VS New Pension Scheme (NPS)

With the increasing number of different investment options, the confusion of the investors also increases. Most of us earlier would consider only FDs as a safe and secure option for creating wealth for retirement or to meet the emergency need of funds. But nowadays people have started changing their mindset and have started investing in NPS and mutual funds instead to meet their retirement needs (particularly) and other needs as well. NPS and mutual funds are both great investment options as both are safe, give tax exemptions, good returns etc. But if an investor wants to choose one of them then the following comparison would definitely come to use.

First of all, before beginning with the comparison let us what NPS actually is?

New Pension Scheme (NPS)

The New Pension Scheme(NPS) is a defined contribution plan. Initially, it was only for government employees but was extended to all the citizens of India by 2009. The main motive of NPS is to inculcate the habit of saving for retirement amongst the citizens.

There are two accounts in NPS:

Tier I Account: This is a non-withdrawal account meant for savings for retirement.

Tier II Account: This is simply a voluntary savings facility. The subscriber is free to withdraw savings from this account whenever the subscriber wishes. No tax benefit is available on this account.

The investor has two options to decide how the contributed funds are invested:

  1. Active choice – Here the individual would decide on the asset classes in which the contributed funds are to be invested and their percentages. The different asset classes available are as follows:
  • Asset class E (maximum of 50%) – investment is majorly in the equity market instruments
  • Asset Class C-investment will be in government securities
  • Asset Class G – investment will be in fixed income securities other than government securities such as liquid funds, fixed deposits etc.
  1. Auto choice – Lifecycle Fund- This is the default option under NPS and under this option, subscriber funds are automatically allocated amongst three funds E, C and G in a pre-defined portfolio pattern prescribed by PFRDA (Pension Fund Regulatory and Development Authority). At the lowest age of entry (18 years), the auto choice will entail investment of 50% of pension wealth in E Class, 30% in C Class and 20% in G Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in E and C asset class will decrease annually and the weight in G class will increase annually till it reaches 10% in E, 10% in C and 80% in G class at age 55. As the subscriber grows old, the investment is shifted more towards secured fund option – Government Securities.

Withdrawal/Exit

Your money is locked in till the age of 60. In case you need funds before the age of 60 (and after 10 years of creating NPS account), then you can withdraw for special reasons, maximum of 20% and opt for annuity for the remaining 80% of the accumulated pension wealth.

Upon attainment of 60 years of age, 60% of the accumulated pension wealth can be withdrawn rest 40% will be used to buy an annuity.

Taxation

Up to Rs. 50,000 investment per year under 80CCD(1B) is tax-free. This is over and above Section 80c limit of 1.5L

NPS is quasi-EET – Principle is tax-exempt, 60% of profit is taxable and 40% is tax-free. Withdrawals from the NPS are tax-exempt if subscribers withdraw up to 40 percent of the corpus when they reach 60 years of age.

Comparison between NPS and Mutual Funds

BASIS NPS Mutual funds
Risk Low-medium Depends on the mutual fund scheme chosen.
Tax benefits Up to Rs. 50,000 investment per year under 80CCD (1B) is tax-free. This is over and above Section 80c limit of 1.5L

Quasi-EET – Principle is tax-exempt, 60% of profit is taxable and 40% is tax-free.

For ELSS it is EEE under section 80C. Equity mutual funds: Short-term capital gain tax is applicable, but long-term capital gain is exempted.

Debt mutual funds: Short and long-term capital gain tax is applicable

Liquidity Illiquid.

Withdrawals from Tier-I account is restricted till the age of 60. And after the age of 60 only a maximum of 60% can be withdrawn, remaining has to be used to buy an annuity.

Liquid.

In ELSS there is a lock-in period of 3 years. And in other mutual funds, if you want to withdraw within a year then you would have to pay some charges. But after a year those charges also become nil.

Withdrawal Early withdrawal before the age of 60 is allowed but only 20% can be withdrawn, rest has to be used to purchase an annuity. Withdrawal cannot be made from ELSS before a period of 3 years. In other mutual funds, there is no such lock in period.
Flexibility Rigid on account of compulsory annuity purchase at the time of withdrawal. Highly flexible, one can choose how the proceeds would be invested.
Choice of assert classes Limited asset class choices-equities, govt. securities and other fixed income securities. Numerous asset class choices are available-equity, debt, real estate, money market instruments etc.
Investment in equities There is a maximum limit of 50% to invest in equities There is no such limit. It is depends on the investors choice and his risk appetite.
Investment The investor has an option to change the scheme preference in active choice. No such option is available. Investment in asset classes are managed by the fund managers.
Cost Low operational costs Comparatively high operational costs
Returns Low; maximum cap on equity is 50% Higher as compared to NPS
Maximum age limit 65 years No maximum age limit

 

Conclusion

NPS is a defined contribution plan which is best suited for conservative investors who do not want to take high risk and are satisfied with limited equity exposure. Whereas mutual funds are best suited for those who are ready to take a comparatively higher risk than NPS and what flexibility to withdraw and use funds as per their own choice. One should not get lured by the tax benefit that the NPS provides, instead consider the returns that mutual funds generate.

Pragati Rajoria

Pragati Rajoria

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About Me

I’m a Commerce Graduate & CFP Professional, engaged in blogging since 3 years. I’m not affiliated with any financial product. The purpose of writing blog is to spread financial awareness and help people in achieving excellence for money. Please note that the views expressed on this Blog/Comments are clarifications meant for reference and guidance of the readers to explore further on the topics. These should not be construed as investment advice or legal opinion.

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