The journey of investments can help you achieve many dreams when done efficiently. One of these goals can be to have a quality life after retirement that is backed by a stable income. Today’s investment choices can significantly impact your post-retirement lifestyle.
Let us look at the two prominent investment vehicles in India for retirement planning – National Pension Scheme (NPS) and Mutual Funds. This blog article offers a comprehensive insight into the features and benefits of both schemes as well as the differences.
What Is the National Pension Scheme (NPS)?
Launched in 2004, National Pension Scheme (NPS) is a government-backed pension scheme which means it carries minimal risk. It caters primarily to salaried individuals and aims to provide a steady stream of income after retirement.
Any Indian citizen (resident or non-resident) who is employed in some capacity is eligible for this scheme, except for the ones in the military service. The applicant must be between the ages of 18 and 70 (on the date of application) to be eligible.
The NPS model is similar to that of a systematic investment plan (SIP) or a recurring deposit (RD) where a fixed amount of money is to be contributed periodically towards the scheme. This contribution is to be made until the investment objectives are fulfilled or the investor reaches retirement age.
The contribution limits for NPS are as follows:
- Minimum of ₹500 while opening the NPS account.
- Minimum of ₹1000 annually (subsequent contributions to keep the account active).
After retirement, the investor can withdraw a part of the accumulated amount while the remainder of the investment is received as a monthly pension.
Who Should Invest in the NPS?
NPS is suitable for individuals with a low-risk appetite and those who want to start planning for an early retirement. This saving scheme can have a significant impact on the post-retirement lifestyle.
Moreover, this scheme can also be beneficial for those employed in the private sector or self-employed. Having a stable pension income after retirement can prove to be a blessing.
The investors opting for this scheme are also eligible for tax deductions upto ₹2 lakh per annum under Section 80C of the Income Tax Act.
What Is a Mutual Fund?
Mutual funds can be defined as a pool of investments where your contributions are diversified across various marketable securities. These funds are managed by professionals who decide the mutual fund’s portfolio.
Investing in mutual funds can be done either as a one-time lump sum or as a systematic investment plan (SIP). SIP enables you to invest in smaller contributions periodically. You can check how SIPs compound over time using Angel One’s SIP Calculator.
Mutual funds can be categorised into two types based on their liquidity.
- Open-ended schemes provide investors with more liquidity as they are easy to enter and exit.
- Close-ended schemes require the funds to be locked until the specified maturity date.
These investments differ in risk rates depending on the make-up of their portfolios. These portfolios can include equity, debt, commodities, market bonds, sovereign papers or even a blend of these.
Who Can Invest in Mutual Funds?
Individuals with a higher risk appetite can choose to invest in mutual funds. Based on the risk appetite, individuals can also choose the type of mutual funds they want to invest in. Mutual funds have a higher risk as they are not backed by the government. However, these schemes need to oblige the SEBI rules and regulations.
Moreover, the mutual funds that follow the market can help you beat inflation. There is no minimum amount for investing in the mutual fund in general but the mutual fund schemes individually may have a minimum investment amount. Mutual funds contributions are eligible for exemptions from taxation up to ₹1.5 lakh under Section 80C of the Income Tax Act.
Difference Between NPS and Mutual Fund
Breakdown of key features for comparison of NPS v/s mutual funds:
| Feature | NPS | Mutual Funds |
| Purpose | Primarily for retirement planning | Multiple goals |
| Tax Benefits | Applicable on interest and maturity [Sec 80C] | Applicable on dividends and capital appreciation [Sec 80C] |
| Investment Options | Limited [Tier I and Tier II] | A diverse range of schemes of various asset classes |
| Lock-in-period | Long lock-in period | Depends on the mutual fund scheme. Open-ended have no lock-in period |
| Risk | Lower as it is backed by the government | Depends on the scheme |
| Returns | Potentially lower than Mutual Funds | Potentially higher than NPS |
| Liquidity | Low [partial withdrawal at maturity] | Higher [for open-ended schemes] |
| Management | Government controlled | Professionally managed by experts |
Tax Implications on NPS and Mutual Funds
Tax treatment plays a crucial role in deciding between NPS and mutual funds.
NPS Taxation
- Contributions to NPS qualify for tax deductions of up to ₹2 lakh per year under Section 80C and Section 80CCD(1B).
- Upon retirement, 60% of the corpus can be withdrawn tax-free, while 40% must be used to buy an annuity that provides a pension, which is taxable as per the investor’s income tax slab.
- If withdrawn before maturity, the withdrawn amount is fully taxable.
Mutual Funds Taxation
- Equity mutual funds:
- Short-term capital gains (holding period less than 12 months) are taxed at 15%.
- Long-term capital gains (holding period more than 12 months) above ₹1 lakh are taxed at 12.5%.
- Debt mutual funds:
- Both short-term and long-term capital gains are taxed as per the investor’s income tax slab.
Taxation laws keep changing, so investors should always check the latest regulations before making a decision.
Mutual Funds or NPS: Which to Choose?
Choosing the better option among mutual funds or NPS would be subjective. One has to consider various factors, such as investment horizon, retirement goals, current savings, risk tolerance, etc, to come to a decision. Both investing avenues provide distinct advantages that cater to different investment needs.
You can opt for NPS as well as Mutual Funds if you are looking for diversification in your investments. While investing, it is important to ensure that the contributions comply with the scheme policies. Moreover, you don’t need separate accounts to manage the investments. Having a Demat account on the Angel One platform can help you invest in various investment avenues including Mutual Funds and NPS! Read how Angel One can help you apply for NPS here. Start investing for your future today!
Strategies for Investors Choosing Between NPS vs Mutual Funds
If you are unsure whether to invest in NPS or mutual funds, consider these strategies:
Diversification Approach
- Invest in NPS for retirement security and mutual funds for wealth creation.
- This combination ensures stability while allowing for higher returns.
Risk-Based Strategy
- If you have a low-risk appetite, allocate a higher portion to NPS.
- If you can handle market fluctuations, allocate more towards mutual funds.
Age-Based Investment Strategy
- If you are in your 20s or 30s, focus more on mutual funds for growth.
- If you are in your 40s or 50s, prioritise NPS for stability.
Tax Planning Strategy
- Use NPS tax benefits to reduce taxable income.
- Invest in equity-linked savings schemes within mutual funds for tax-saving benefits under Section 80C.
Goal-Oriented Strategy
- If you are investing specifically for retirement, NPS is a solid option.
- If you have short-term or multiple financial goals, mutual funds offer more flexibility.
By carefully planning your investment approach, you can optimise returns while ensuring financial security for the future.
Conclusion
Choosing between NPS and mutual funds depends on individual financial goals, risk appetite, and investment horizon. NPS provides a disciplined approach to retirement savings with tax benefits and stability, making it ideal for risk-averse investors. On the other hand, mutual funds offer flexibility, growth potential, and a variety of investment options for those willing to take on more risk.
A balanced approach that includes both investment options can help build a strong financial foundation for the future. Investors should review their financial situation regularly and make informed decisions that align with their retirement and wealth-creation goals.
FAQs
What is the National Pension Scheme (NPS)?
NPS is a government-backed pension scheme for Indian citizens aged 18 to 70, except military personnel. It offers stable retirement income with minimal risk and requires periodic contributions until retirement.
Who should invest in NPS?
NPS is ideal for those with a low risk appetite, including private sector employees and the self-employed. It offers a stable pension post-retirement and allows tax deductions up to ₹2 lakh under Section 80C.
What are mutual funds and how do they differ from NPS?
Mutual funds are professionally managed pools of investments diversified across securities. They carry higher risks than NPS but offer potentially higher returns and are suitable for those with higher-risk appetites.
What are the key differences between NPS and mutual funds in terms of features?
NPS focuses on retirement with a long lock-in period, lower risk, and returns due to government backing. Mutual funds serve various goals with higher risk and returns, no lock-in for open-ended schemes, and a broader range of investment options.
How can one invest in NPS and mutual funds?
Deciding between NPS and mutual funds depends on factors like investment horizon, retirement goals, and risk tolerance. Both can be part of a diversified strategy. Investments can be managed through a Demat account on the Angel One platform, which also assists in applying for NPS.
