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Difference Between NPS vs Mutual Funds – Which is a Better Investment Plan

This article focuses on comparison between NPS and Mutual Funds. Know their distinctive features, taxation and more.

Financial products for retirement planning

An individual can do their retirement planning through various financial products. For example, an individual with a conservative risk profile can do their retirement planning by regularly investing in a Public Provident Fund (PPF) account. If the individual wants to have the option of investing in equity and debt, shuffling between them, and later purchasing an annuity, they can do their retirement planning by investing in the National Pension Scheme (NPS). Another way of planning for retirement is by building a portfolio of mutual fund schemes with appropriate asset allocation. This blog will focus on the difference between NPS vs mutual fund – Which is a better investment plan.

What is the National Pension Scheme (NPS)?

The NPS is a defined contribution scheme in which individuals can regularly invest during their working years to build their retirement fund. Investors can decide how their money should be invested based on their risk profile. The contributions are eligible for deduction from taxable income under Section 80C of the Income Tax Act. On retirement, the individual can withdraw up to 60% of the accumulated corpus tax-free (commutation). With the remaining amount, the individual has to buy an annuity that will give period cash flows. The annuity received is taxable as per the individual's tax slab.

Features of NPS

Any Indian citizen aged between 18 to 70 years can open an individual account under the NPS. The individual gets a Tier I account in which they have to make initial and subsequent contributions. They have to make a minimum of 1 contribution in a year. The account holder should deposit a minimum of Rs. 1,000 in a year, or else the account will be frozen. They also have the option to open a Tier II account. 

The account holder can choose to invest their contributions in various funds, including equity, Government securities, corporate bonds, alternate investments, etc. The account holder can also select the "Auto Choice" option. In this option, the money is invested in various asset classes as per the account holder's age. As the account holder ages, the asset allocation is adjusted by reducing the equity exposure.

On attaining the age of 60, the account holder can withdraw up to 60% of the accumulated amount. The remaining amount has to be used to purchase an annuity. There are various annuity payment options available to choose from.

What is a systematic investment plan (SIP)?

A SIP is a mode of investing in a mutual fund scheme. In a SIP, the investor makes regular contributions of a specified amount for a specified period. For example, Bobby has started a monthly SIP of Rs. 5,000 on the 5th of every month for five years in an equity mutual fund scheme.

Features of SIP

A SIP allows an individual to make regular contributions as per their income. Most AMCs provide the investor with an option to increase the SIP amount by a specified amount or percentage annually. The SIP can be paused or redeemed before maturity. 

A SIP allows the investor to benefit from the Rupee Cost Averaging (RCA) concept. When the market falls, the investor accumulates more units at a lower Net Asset Value (NAV). Later, when the market recovers, the investor benefits as the value of the units will go up. SIPs are an excellent option for long-term financial goals such as building a fund for a child's higher education or building a retirement fund for self.

Taxation: NPS vs SIP

NPS: An individual can contribute up to 10% of their salary to NPS and claim a deduction from taxable income under Section 80CCD(1). The maximum deduction allowed in a financial year is the amount contributed or Rs. 1,50,000. An individual can contribute up to Rs. 50,000 in NPS and avail an additional tax benefit under Section 80CCD(1B). The employer can contribute up to 10% of the employee’s salary towards NPS. The employee can claim a deduction for this contribution under Section 80CCD(2).

On reaching the age of 60 years, an individual can withdraw up to 60% of the accumulated amount tax-free. This is known as commutation. The remaining amount has to be used to purchase an annuity. The periodic annuity amount the account holder receives is taxable as per the tax slab.

SIP: An individual cannot claim a tax deduction for SIP contributions except for equity linked savings scheme (ELSS). For ELSS SIP, an individual can avail of a deduction from taxable income under Section 80C of the Income Tax Act. The maximum deduction allowed in a financial year is the amount contributed or Rs. 1,50,000, whichever is lower.

At the time of redemption, the capital gains are taxed as per the holding period. In the case of an equity fund, if the holdings have been redeemed within 12 months, the short-term capital gains tax is levied at 15%. If the equity fund holdings have been redeemed after 12 months, the first Rs. 1 lakh long-term capital gains (LTCG) will be exempt. The incremental LTCG will be taxed at 10% without indexation.

NPS or mutual fund: Which one should you choose?

The National Pension Scheme (NPS) is specifically meant for accumulating money for retirement. On the other hand, mutual funds can be used for various financial goals, including accumulating money for retirement. Mutual funds provide you more choice in terms of types of funds such as large, mid, small, multi, flexi, sectoral, thematic, hybrid, etc. On the other hand, NPS gives you additional tax benefits over mutual funds under Section 80CCD (1B) and Section 80CCD(2). An individual should evaluate their needs and accordingly choose between mutual funds or NPS. An individual can also invest in both. So, rather than choosing a mutual fund vs NPS, you can also go for a mutual fund and NPS combination.

To start investing in mutual fund schemes as per your appropriate asset allocation, download the Glide Invest App from Google Play Store or Apple App Store and get started.

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