NPS vs. Mutual Funds: A Retirement Planning Perspective

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.

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Partial withdrawals are allowed after completion of 3 years of NPS subscription and are capped at 25% of the contribution made by the subscriber. This limit of 25% falls within the overall 40% exemption limit of NPS payments. It means that once you have exhausted 25% exemption limit under partial withdrawals, then you will be left with only 15% of the exemption limit which you may avail upon receiving 60% lump sum on superannuation. Earlier, the deduction allowed under Section 80CCD is 20% of the gross total income of the self-employed.

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:

1. Liquidity

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.

2. Flexibility

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.

Also read: Reverse Mortgage Loan enabled Annuity (RMLeA): A better option over Reverse Mortgage Loan (RML)

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.

6. Cost

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 Outgo

Since 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

Final Words

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

About the author

KishorKumar Balpalli, believes that financial literacy and discipline is the key to one’s financial freedom. KishorKumar is a Certified Financial Planner, Personal Finance Blogger & the Founder of an award-winning Wealth Management platform. myMoneySage simplifies investing for individuals and amplifies business growth for Registered Investment Advisers by leveraging Artificial intelligence and machine learning. The AI of the machine plus the intellect of the human advisor enables comprehensive & client-centric advice at a fraction of the cost of a conventional adviser. is an award winning personal finance platform. It helps you aggregate all your personal finance accounts like FD, Equity, Mutual Funds, PPF EPF, NPS including, Credit Cards & Loans etc. It's one place where you can track, plan and invest seamlessly. empowers you to invest in zero commission direct plans of mutual funds thereby helping you generate higher on investments. The best part is it comes with a lifetime Free plan.

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  • Hi Kishore,

    Nice Article. I have a query. i do not have NPS now, for tax exemption under 80c i have other investments like
    ELSS, EPF,PPF etc., If i start and invest 50000 in NPS, can i add this as a deduction under sec 80 ccd 1(b) ?

    • Mymoneysage says:

      Dear Vijay

      Firstly, thanks for reading the article!

      Budget 2016 came up with exciting changes as regards NPS. The tax exemptions allowed for NPS contributions are dealt under 2 sections mainly:

      Section 80C – Your NPS contribution of up to Rs 1.5 Lakh can be claimed as tax exemption.
      Section 80CCD(1b) – This allows you to claim NPS contribution of Rs 50,000 over and above the exemption availed under Section 80C.

      So, if you have already exhausted your Section 80C exemption in other investments like ELSS, EPF, etc, you can still contribute Rs 5000 to NPS and claim it as an exemption.

  • Kyle Rolek says:

    I think mutual funds are better option for retirement plans they can give more benefits as compare to nps.Thanks for your post.

    Kyle Rolek

  • Soham Sinha says:

    Hi. Is the comparison of NPS and Mutual Funds apt? Instead shouldn’t one compare this to other annuity products? To my knowledge NPS can be used in addition to Mutual Funds. The 50K tax exemption means that a person in the 30% tax bracket is investing INR 15,000 annually, which he would have otherwise paid as taxes (u/s 80 CC D 1B: NPS provides additional tax exemption on 50000, no other product offers this).

    Had the person ignored NPS, he would have been only investing 35K, since he will be paying taxes of INR 15000 to the govt. So even if I were to assume a moderate growth of 9% (on the 15K saved in taxes) in NPS between 30-60 yrs for an investor, the tax savings would result in a corpus of over 20,00,000. Remember im only speaking of the 15000 saved through taxes.

    So if a comparison has to be made it should be made between NPS and other annuity products. This is only my opinion and look forward to hearing your views on this.

  • 2Cool_Monk2 says:

    This article has compared NPS and MFs as investment mechanisms – which is really misleading. NPS is a retirement product and should, therefore be assessed in that light only, and as nothing else. NPS is a government promoted product, will therefore be made more attractive over EPF, PPF, Pensions in time to come. This overall direction is already visible is annual budgets. It is commonsense – it is government’s interest to make NPS successful, therefore people are being slowly nudged to subscribe to NPS.

    • Mymoneysage says:

      Dear Cool Monk

      Thanks for reading the article!

      Undoubtedly, from a retirement planning standpoint, Mutual Funds are a far superior haven than NPS on 3 counts:

      1. The equity potential of Mutual Funds is way higher than NPS. Where NPS limits the wealth accumulation via equities to 50%, Mutual Funds present limitless opportunity to become wealthy via equity investing. You can invest 100% of your planned corpus in equities.

      2. Tax incentives available in Mutual Funds are higher than NPS. After holding period of 1 year,your returns in equity mutual funds become tax-free. Whereas in NPS, taxation of fruits of investment is staggered. 40% of the corpus will be lost in taxation when you get it either on maturity or as partial withdrawal.

      3. Mutual Funds are extremely flexible and convenient investment options. There’s no compulsion to purchase any annuity upon redemption of investment. The entire capital appreciation earned goes into your kitty.

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