NPS Or Mutual Funds: Which One Should You Choose?

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NPS Or Mutual Funds: Which is the Better Investment?

NPS Vs Mutual Funds: An Overview

The purpose of retirement planning necessitates a carefully thought-out strategy. While, historically, investing has been a wise approach to build discipline and financial security to build a secure-after-retirement life. Now, over the years, many investors have come to understand the value of saving and investing due to the market's regular volatility and employment instability, particularly during these difficult times. At the same time, saving money through the right mode has become a tricky job, as today,  there are so many investment possibilities that it may sometimes appear to be confusing.

In this article, we shall compare two of the currently debated investing options: mutual funds and NPS. Despite the fact that both of these are market-linked and offer a number of the same advantages, there are some important distinctions between them as well as unique individual benefits. We shall examine each of these plans and understand which scheme outrides the other as per an investor's financial goals and suitability.

What is NPS?

The National Pension Scheme (NPS), an initiative of the Indian central government, is open to employees from the public, private, and unorganized sectors. In this scheme, Investors can open an NPS account and make a recurring deposit. After retirement, the member has the option of taking a partial lump sum payout from the said deposit. This investment amount is eligible for a standard deduction of Rs. 1.5 lakh under section 80C of the Income Tax Act 1961. In addition, section 80CCD of the Act permits the investor a maximum deduction of Rs 50,000 each fiscal year.

Benefits of National Pension Schemes

  • Due to government backing, investing in NPS has a very minimal risk. And is therefore one of the most secure investing possibilities.
  • Investors' demands for long-term investments are satisfied by NPS.
  • The scheme provides tax advantages under Sections 80C and 80CCD of the Income Tax Act 1961.
  • After you create the necessary Tier I account, you can start an optional Tier II account with a minimum contribution of Rs. 1000, which, unlike the Tier I account, can be withdrawn fully.
  • After 2016, NPS withdrawals are tax-free up to 40% of the total accrued amount.
  • From the seven accessible funds, NPS is thought to be the sole investment choice that permits investors to switch the fund manager once every fiscal year.
  • The four asset types that NPS investors invest in are equity, corporate debt, government bonds, and annuities. Because NPS funds are exposed to a variety of assets, the risk is dispersed, which lowers the risk of volatility in the equity market.

What are Mutual Funds?

A mutual fund is a pool of money that is professionally managed by a Fund Manager. It is a trust that gets funding from a group of individuals with similar financial goals and invests it in stocks, bonds, money market instruments, and many other such assets. Mutual funds, after subtracting appropriate fees and taxes, disperse the income and profits created by this collective investment proportionately among the participants, after determining the respective scheme's Net Asset Value or NAV. Simply said, a Mutual Fund is a collection of money contributed by a diverse group of individuals.

Benefits of Mutual Funds

  • It is managed by a group of money management specialists who work tirelessly to optimize investment growth possibilities.
  • Mutual funds provide diversified portfolios of stock, debt, market size, sectors, and industries.
  • It is a relatively inexpensive investment in exchange for expert management, flexibility, and variety. Where a mere charge of 0.50% to 1.50% is levied.
  • You can redeem your assets at any moment, with no lock-in period. However, if you have ELSS investments, you are subject to a 3-year lock-in period. 
  • SIPs, or Systematic Investment Plans in mutual funds, create a sense of confidence while investing.
  • As previously stated, because most mutual funds have no lock-in period and are open-ended, they provide high liquidity. In the event of a financial crisis, investors may rely on mutual funds.
  • Mutual funds are far more flexible than other investment programs, owing to their lack of a lock-in term. The investor has the option to enter and quit a mutual fund at any time.

NPS vs Mutual Fund Comparison: Which is Better?

Here is a detailed explanation of the difference between NPS and mutual funds. By differentiating between mutual funds and NPS, the following characteristics or metrics will assist you in making the best decision for you.

  1. Allocation of Equity and Exposure: Where ELSS invests predominantly in equity-oriented mutual funds, NPS has a reduced allocation of money to equity-oriented mutual funds. As a result, ELSS has a greater potential for higher returns than NPS.
  2. Exposure to Risk: NPS certainly has lesser risk, because ELSS has greater exposure to an equity-oriented mutual fund, the investment risk is likewise larger. The risk factor, on the other hand, is determined by the amount of risk an investor is willing to take based on his or her personal cost and expenses. 
  3. Tax Deduction: Both investing alternatives have tax advantages. However, the tax benefits of NPS outweigh those of equities mutual funds, whose long-term profits are taxed at 10% on exit. NPS plans provide a bigger tax deduction of up to Rs 2 lakh under Sec 80C, compared to Rs 1.5 lakh for ELSS plans. The benefit of NPS is that you can withdraw up to 60% of the whole corpus as a lump amount at maturity, with 40% tax-free.
  4. Fund Management Costs: With 0.1% management costs, NPS is the most affordable managed fund for retirement. The expenditure ratio charged by asset management firms or mutual funds ranges from 0.50% to 1.50%, which is significantly more than the cost of NPS administration.
  5. The flexibility of Withdrawals: The Tier I NPS investment, which is required to start an NPS account, contains withdrawal restrictions. You cannot reclaim your whole investment until you have completed at least 10 years or reached the age of 60. However, you may withdraw in part if the criteria are met, up to a maximum of 25%. As a result, you have little investing freedom. Investment in stock through NPS is limited to 75% of your total NPS investment.

Equity mutual funds, whether in the tax-advantaged ELSS form or otherwise, provide you with a lot more choice in terms of selecting alternatives, schemes, and investing time horizons; use this flexibility to develop the retirement corpus that best suits you.

Suggestions for Investors While Selecting NPS Vs Mutual Fund

When it comes to choosing amongst the available investment alternatives, both NPS and Mutual Funds inculcate financial discipline in an investor’s life because the cash is automatically withdrawn from your registered account at specified intervals. Now, because of the flexibility they provide, mutual funds are frequently used as emergency savings. One has the option of withdrawing the funds, as per the requirement. NPS does not have such options, as a result, it is recommended to invest in NPS when you are at the stage of your retirement when the main motive of investment for the investors is usually availing of tax advantages and investing in low-risk

Furthermore, you can save taxes during your employment since NPS provides a tax deduction of up to Rs.1.5 Lakh for your and your employer's payment to the program under Section 80CD of the Income Tax Act. Furthermore, you can claim any additional self-contribution (up to Rs.50,000) to the program as an NPS tax advantage under Section 80CCD. In addition, in the 2019 budget, NPS was classified as EEE (Exempt-Exempt-Exempt).

This means that NPS subscribers may claim tax deductions on NPS payments, returns received on NPS contributions are likewise tax-free, and with tax advantages extended on lump sum withdrawals, NPS now qualifies as an Exempt-Exempt-Exempt (EEE) type. Mutual fund capital gains, in contrast, are taxed both in the short and long term.

Given their commonalities and contrasts, one can choose between the two investing alternatives based on their financial goals. If your primary goal in investing is to ensure your financial future, NPS must be your initial pick. Mutual funds are often popular among those who have a high-risk tolerance, have short-term financial goals, and can also serve other purposes.

  • Can funds in NPS be transferred across categories?

  • How many mutual funds and NPS investments can an investor make?

  • Are mutual funds and NPS regulated by the same body?

  • Is NPS deductible under 80C of the Income Tax Act 1961?