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Sunday, December 29, 2013

NPS vs Mutual Funds- Which is Better Retirement Investment?

NPS vs Mutual Funds- Which is Better Retirement Investment?

National Pension Scheme (NPS) was thrown open to individual subscribers from the unorganized sector (not government employed, in NPS parlance) in May 2009. NPS is basically a retirement scheme. Once you start a NPS tier I account you can withdraw only at 60 years of age. There is also a tier II NPS account from which intermediate withdrawal is permitted.

With NPS functioning in a similar manner as mutual funds, where pooled money of investors is allocated to various assets and managed by fund managers, many investors would be interested in knowing which of the two- NPS or mutual funds is a better retirement investment option.

Below we will take you through a few parameters for comparison between the two.


It is interesting to compare NPS returns with respect to returns from Mutual Funds. In the table below you will see that average returns from NPS funds are better than average returns of mutual funds belonging to the same category.

Asset class
Avg NPS returns
Avg MF returns

 *Nifty based mutual funds have been chosen
Average NPS returns above reflects tier I and tier II returns. As of now tier I returns are higher than tier II returns in all three assets classes.

It would be unfair to say NPS returns are better than MF returns from just the average. Returns from the best MFs are much better than the average and of course, also less than average in worse funds.Unlike in NPS where you have only 6 fund houses, in mutual funds there are 44 fund houses to choose from. Returns from funds belonging to same category, say Nifty funds, but managed by different fund houses vary widely in case of mutual funds.Since NPS has just about 4 years of performance record, subscribers will have to wait and see how successful the PFMs turn out to be in maintaining current records.


Here NPS is a clear winner. Charges including transaction fee and fund management charges in NPS come to about 0.5% whereas Nifty mutual funds have a charge of about 1.5% (a little lesser in direct plans). A difference of 1% will bring a huge difference in final returns over a period as long as 20, 30 years or so.


NPS tier I comes under EET regime. This means investment amounts (up to Rs 1 lac subject to overall 80C cap) has tax benefit. Intermediate gains in your NPS deposit are not taxed. Tax has to be paid only on the amount you withdraw from NPS. From tier 1 account maximum 60% can be withdrawn on reaching the age of 60. The rest is to be used to buy an annuity product.

In contrast, nifty based mutual funds do not have 80C benefit. If you opt for dividend, dividend distribution tax is applicable. If instead you opt for growth option then on withdrawing from mutual funds, capital gains tax is to be paid. However, equity funds have zero long term capital gains tax.

In ELSS (tax saver mutual funds) the invested amount gets 80C benefits along with zero long term capital gains tax. Dividend distribution tax is however applicable.

When DTC comes around NPS tier I will have a clear upper hand from taxation view as well since it is expected to enjoy EEE regime, doing away tax on withdrawal as well.

Transaction ease

NPS has room to catch up on this one. Individuals were allowed to invest in NPS only from 2009. Presently in order to invest one has to visit one of the Points of Presence, which could be banks or others registered with PFRDA as service provider. Presently online facility is not available in NPS.
Mutual funds are a much evolved product as far as services are concerned. First time forms need to be submitted physically but many distributors would gladly send an agent over to collect them from you.  Subsequently you can do MF transactions online.

Asset allocation

This is very important while planning for a goal like retirement. In NPS you can yourself choose and alter proportion of investment in E, C and G classes through Active mode or go for automatic age-based proportion through Auto mode. However a major drawback is that maximum allocation in E class is 50%.Towards starting ages one can have more exposure to equity and lower it systematically. Also equity portfolio in NPS is passively managed. Funds are invested in an index (presently Nifty). An actively managed equity portfolio can give better returns.

NPS has several benefits over mutual funds as a retirement benefit product, the most important ones being lower charges and tax savings. Tier I account locks in money till retirement and ensures that it is used for the original goal. If you are young you can allocate more in actively managed equity mutual funds and some in NPS.


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