Are you confused among different retirement planning options in India?
Choosing ‘NPS or mutual funds’ for your retirement planning can be a tough choice! But you can relax, as we have made it easier to understand with the story of Anita and Rahul.
Anita
Rahul, I am thinking a lot about retirement these days. It is becoming more urgent. Our parents had pensions, but for us, it is very different. With rising life expectancy and nuclear families, we really need to plan independently, right?
Rahul
Absolutely! You are not alone with this concern. India’s demographic landscape is changing. By 2050, nearly one in five Indians will be above 60. With a lack of guaranteed pension, robust financial planning with appropriate instruments is required.
Anita
I have heard about the National Pension System (NPS) and Mutual Funds being popular retirement planning tools. I have heard about mutual funds and NPS benefits. Particularly the tax benefits in a NPS scheme sound very effective.
Rahul:
To choose NPS or mutual funds is an important question, and a very timely one. NPS or mutual funds are powerful in their own ways, but they serve slightly different purposes.
Let us learn more about NPS tax benefits and its role in smart retirement planning role below:
Understanding Retirement Products
Anita
Let’s start with the basics. What exactly is a NPS scheme?
Rahul
NPS is a government-backed retirement scheme, regulated by the Pension Fund Regulatory and Development Authority (PFRDA). It is specifically designed to ensure financial security in your post-retirement years. The system has two accounts: Tier I and Tier II.
- NPS Tier I is the primary retirement account. The contributions made here are locked in until you reach 60 years of age. It can provide NPS tax benefits.
- NPS Tier II account is optional and can work like a regular investment account without lock-in.
However, tax benefits for Tier II exist only for government employees and require a 3-year lock-in; for others, there is no lock-in and no tax benefit.
Anita
This sounds interesting! How can I invest my money and do I have any control?
Rahul:
Yes, you do. There are two investment choices:
- Active Choice - Here you can decide the proportion of equity (E), corporate debt (C), government securities (G), and alternative assets (A)
- Auto Choice - This adjusts your portfolio automatically based on your age reducing equity exposure as you approach retirement.
The asset classes are diversified into:
- E (Equity): For long-term growth
- C (Corporate Bonds): Moderate-risk, stable returns
- G (Government Securities): Low-risk, steady income
- A (Alternative Investments): For advanced investors (limited exposure)
The best part? It’s managed by professional pension fund managers under the vigilant eye of PFRDA. So, between NPS or mutual funds, we know about NPS now!
But what about Mutual Funds?
Mutual Funds are very different in nature. They are professionally managed investment vehicles regulated by the Securities and Exchange Board of India (SEBI). You invest in a pool of money that could go into equities, bonds, or a mix, depending on the fund type and your financial goal.
For retirement, some of the commonly chosen categories are:
- Equity Funds for long-term capital appreciation
- Debt Funds for lower-risk, stable income
- Hybrid Funds blending both, debt and equity
- ELSS (Equity-Linked Savings Scheme) for tax-saving under Section 80C with a 3-year lock-in, under the old tax regime.
Check this blog to understand different NPS benefits.
NPS or Mutual Funds - A Strategic Comparison
Now comes the real question!
How do NPS vs Mutual Funds compare on critical parameters like security, returns, tax savings, and retirement readiness?
Regulatory Authority & Security
NPS Scheme: It is regulated by PFRDA, which ensures strict governance, transparency, and security. It is built for steady retirement planning.
Mutual Fund Scheme: It’s governed by SEBI, highly regulated and transparent, but their purpose might not be exclusively retirement.
Investment Strategy & Asset Allocation
NPS Scheme: NPS has disciplined allocation and in-built rebalancing through Auto Choice. The limited exposure to equity (maximum 75%) can ensure controlled volatility.
Mutual Fund Scheme: You can enjoy a greater freedom to choose high-growth equity funds, conservative debt funds, or hybrids. However, this freedom comes with responsibility that you or your advisor need to monitor and rebalance it regularly.
Tax Benefits (The NPS Advantage)
NPS Scheme: One of the strongest points. Under old tax regime, you can get the following NPS benefits:
- Up to ₹1.5 lakh deduction under Section 80CCD(1) (part of 80C).
- An additional ₹50,000 under Section 80CCD(1B), exclusive to NPS.
- Employer contribution up to 10% of salary (basic + DA) (14% if such contribution is made by Central Government) is also tax-exempt under Section 80CCD(2).
This makes up to ₹2 lakh+ in tax deductions annually, a significant advantage over most other instruments.
Mutual Funds (ELSS): ELSS can offer 80C deduction up to ₹1.5 lakh. But that is shared with other expenses like EPF, insurance premiums, and more.
Liquidity & Lock-in Period
NPS Scheme: Tier I account is locked until age 60, instilling discipline. Partial withdrawals are allowed for specific purposes like illness, education, or home purchase, but only after 3 years and within limits.
Mutual Fund Scheme: It can have a higher liquidity.
For understanding the NPS withdrawal rules, click here.
Returns & Cost Efficiency
NPS Scheme: Returns are market-linked with lower expense ratios.
Mutual Funds: Can offer higher returns, especially through equity funds, but also come with higher volatility and expense ratios (typically 1–2.25%).
Annuity & Post-Retirement Income
NPS Scheme: At retirement (age 60), you can use at least 40% of your corpus to purchase an annuity, which gives you a guaranteed monthly pension. The remaining 60% can be withdrawn tax-free.
Mutual Funds: You can choose SWP (Systematic Withdrawal Plan) for income, but returns are market-dependent, and there is no guaranteed income unless you buy a separate annuity product.
NPS or Mutual Funds - Which’s Better?
For choosing between NPS or mutual funds, here’s a simple rule of thumb:
NPS Benefits Are For You If You:
- Are looking for a guaranteed (min. 40% of corpus) income stream post-retirement.
- Prefer a government-regulated, low-cost retirement plan.
- Are looking to maximise tax savings under both 80C and 80CCD(1B).
- Need a structured approach with minimal monitoring.
Choose Mutual Funds (alongside NPS) if you:
- Are looking for greater flexibility in investments.
- Are comfortable with market-linked risk for potentially higher returns.
- Need liquidity and accessibility for non-retirement goals.
- Want to supplement your retirement corpus with aggressive or hybrid growth.
Other Retirement Planning Instruments
Here’re a few other retirement instruments that many people rely on in India:
1. EPF (Employees’ Provident Fund)
A mandatory savings tool for salaried employees. Both employer and employee contribute, and the returns are tax-free if held for 5 years.
2. PPF (Public Provident Fund)
Open to all citizens with a 15-year lock-in, PPF offers tax-free interest and maturity. It can be better for risk-averse investors and can complement NPS well.
3. SCSS (Senior Citizens’ Saving Scheme)
Designed for individuals 60+, it offers a high fixed interest rate and quarterly payouts, for post-retirement income.
4. APY (Atal Pension Yojana)
Tailored for the unorganised sector, it can ensure a fixed pension post-60. Contributions are lower, but benefits are guaranteed.
Anita
That is a comprehensive list indeed! But it sounds like each has a role to play.
Rahul
Exactly. Depending on your income, career stage, and risk profile, you can use a mix. But NPS remains the only one exclusively structured for long-term pension planning.
Anita
Thanks, Rahul. I now see that a NPS scheme is not just as a savings tool, but also a disciplined path to ensure stability in my retirement years.
Rahul
Exactly. NPS benefits can include structure, tax benefits, and a guaranteed retirement income, things that are non-negotiable in today’s financial landscape.
Conclusion
You can conclude the NPS or mutual funds discussion by planning your NPS and mutual funds investments! A proactive retirement planning now can ensure financial security later, post-retirement. With NPS as your cornerstone and Mutual Funds supporting your growth, you will be well on your way to a worry-free retirement.
Take your first step towards post-retirement financial security, start investing in NPS now.
