Here is a comparison between NPS and Mutual Funds:
The New Pension Scheme (NPS), a defined-contribution scheme initially launched for the government employees, was extended to all the citizens of India by the end of 2009. It is an ambitious annuity plan aimed at building a vast corpus to provide regular income to you, post-retirement. It replicates the working of the mutual funds i.e. pooling money from many investors and investing it in various asset classes to provide them returns while simultaneously charging a fee for professional management.
Under NPS, regular voluntary contributions from you are directed towards the portfolio containing asset classes of your choice which are managed by the professional fund managers to provide market-based returns on investment. After a minimum lock-in period of 3 years, partial withdrawal is allowed as per the conditions stipulated by the PFRDA. On retirement, you would receive 3/5 of the corpus i.e. 60% in a lump sum. The remaining 40% of the corpus would have to be compulsorily used to purchase an annuity from the notified annuity service provider being a life insurer and you will receive a pension in the form of a fixed monthly income.Click here to be a part of myMoneySage Elite an exclusive community to the elite and discerning who want to maximize their wealth by leveraging the power of unbiased advice Changes proposed in Budget 2018 The Finance Minister has proposed a few changes in the Budget 2019 which would impact the taxability of NPS. Any payments from NPA trust would be exempt up to 60% of the amount received either on maturity or on the closure of the scheme for both employees as well as non-employees.
NPS model is picking up in India gradually after having received a tepid response initially.Since inception in 2009, the subscriptions have surged from 4 lakhs to 115 lakhs and the asset under management (AUM) have swollen from Rs. 2,277 Crore to 2,30,761 Crores as on March 2018. Despite having a similar investment mechanism, investors consider NPS a safer bet as compared to mutual funds. The reason being that NPS is a government promoted the scheme and investors mistakenly perceive it to render safety of investment and guaranteed returns. You too might have given investing in NPS a thought, but there is a need to relook its attributes before making a leap.
The NPS model suffers from the following inefficiencies, as shown in the table, which makes Mutual Funds a better investment option from retirement planning perspective:
Whenever you consider investing your money, liquidity happens to be one of the primary concerns. NPS can be looked upon as a highly illiquid investment. Withdrawals from the Tier-1 Account are restricted up to three years from the date of initial investment. Afterwards, although the withdrawals are allowed in tranches, it is only for specific purposes like children’s education or marriage, illnesses like cancer, renal failure, organ transplant etc.
If you want to exit before turning 60, then you will receive only 1/5 of the accumulated corpus, and the rest 80% would have to be used to purchase annuity plan from a notified life insurer. This lump sum receipt increases to 60% when you exit at 60 years while 40% would still have to be deployed for annuity purchase. So, your money gets locked once you invest in NPS. On the contrary, mutual funds are extremely liquid investments which can be redeemed in the case of any contingency.
The NPS restricts your investment freedom not only at the accumulation phase but also at the distribution phase of your retirement journey. When you redeem your investment from NPS, you do not get the entire invested corpus. You may desire to invest your corpus in some other vehicle, but you cannot do so, as compulsorily you have to purchase pension plan from the specified annuity service provider. Thus, NPS restricts your flexibility not only at the time of entering the scheme but also at the time of exiting the scheme via compulsory annuitize of your corpus. It is rigid as it prescribes the age at which you should exit and if you want to exit beforehand, then it penalizes you by annuitize a higher percentage of investment corpus. Then there are rigidities for changing the fund allocation pattern, minimum contribution amount and frequency of contributions.
On the other hand, mutual funds don’t impose mandates to purchase annuities. You can enter and exit from a mutual fund scheme as per your discretion and freely re-balance the MF portfolio as per the movements of the market.
3. Choice of Asset Classes
In NPS, you get limited asset classes to choose from i.e. equity, government securities and other fixed income securities. In the case of mutual funds, a vast array of asset classes is available like equity, debt, gold, real estate, etc. You can invest in an MF scheme which is according to your investment preferences and risk appetite and which provides you with a higher reward for every unit of risk assumed.
4. Maximum permissible equity exposure
NPS tends to be more suitable for conservative investors who don’t prefer taking more than average risks. Especially, in the auto-choice option, the asset allocation is calibrated such that as you get older, automatically the equity exposure keeps falling and stays at 10% once you reach 55 years. An aggressive investor, under the active choice, would be at a significant disadvantage because the maximum equity exposure is capped at 50%. It means that you can’t ask your NPS account to have equity exposure beyond 50% at any point of time. Conversely, the mutual fund is a better bet for a high-risk taker as he can explore varied equity investment options wherein even 100% of the investment can be parked in equity funds.
5. Restriction on choice of Pension Fund Manager (PFM)
PFRDA has appointed six entities which would manage the retirement corpus of individuals under NPS. If you want to join NPS, then you have to choose one pension fund manager at the time of registration from the following:
• HDFC Pension Management Company Limited • ICICI Prudential Pension Funds Management Company Limited • Kotak Mahindra Pension Fund Limited • Reliance Capital Pension Fund Limited • SBI Pension Funds Private Limited • UTI Retirement Solutions Limited • LIC Pension Fund Ltd.
There are about 44 mutual fund houses in India offering over 2185 MF schemes. Instead of sticking to NPS, you may go for a mutual fund house of your choice based on fund factors like the pedigree of the fund house, risk-return analysis, expense ratio and frequency of turnover.
On the operational cost front, NPS is a cost-effective alternative as compared to Mutual Funds. It is so because the government has capped the expense ratio at 0.25% per annum. As opposed to that, the expense ratio limits of mutual funds range from 1.5% to 2.5%. The expense ratio of some fund houses could be even above the ceiling. So, investing in NPS can be considered if only operational cost is taken as a criterion for comparison.
7. Higher Tax OutgoSince NPS comes under EET regime, 40% of the accumulated corpus at the time of closure is taxable at your marginal income tax rate unless you buy an annuity plan. The tax is applicable on the entire corpus you receive which includes your contributions as well as the gains you have made. However, in mutual funds, you have to pay tax only on the gains you have made at the time of redemption. Apart from the factors mentioned above, the tax implications of NPS may also be given a scrutiny. Taxability of NPS is discussed under Section 80C and Section 80CCD. Under Section 80C, your periodic contributions to NPS are allowed as tax deduction up to the prescribed limit of Rs 1.5 Lakh. Moreover, under Section 80CCD(1b), additional deduction of Rs. 50000 is allowed over and above the deduction available under Sec 80C. 60% of the lump sum that you get on withdrawing from the NPS on attaining 60 years is tax free while the rest 40% of the corpus is tax-free if annuity plan is purchased from the notified annuity service provider in the same year of the receipt of the corpus.
Despite additional tax exemption of Rs 50000 that you are getting on NPS which makes you perceive NPS as a better option to ELSS, the taxability of the 40% corpus on redemption offsets the initial tax benefit. Thus, NPS is inferior to ELSS because the long term proceeds of ELSS are completely tax exempt.
Also read: Choosing between PPF, NPS & ELSS
NPS is defined contribution scheme which will provide you fixed monthly income out of the retirement corpus created till 60 years of age. As far as its retirement planning attribute is concerned, it is best suited for conservative investors who don’t want to take high risks and are satisfied with a limited equity exposure. Additionally, its restrictive nature and compulsory annuity purchase make it an unsuitable product.Disclaimer: This article should not be construed as investment advice, please consult your Investment Adviser before making any investment decision. If you are looking for a SEBI registered Investment Adviser visit mymoneysage.in