Equity mutual funds or NPS, which is more beneficial?

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The National Pension System, or NPS, and equity mutual funds are both long-term investments. People often get confused about where to invest between NPS and mutual funds. Which is better, NPS or equity mutual funds? Both NPS and equity mutual funds have their own benefits and drawbacks. Let’s find out which scheme is right for which type of investor.

Every investment is made with some purpose or objective in mind. NPS is a long-term retirement-focused investment, designed to provide regular income after retirement. Equity mutual funds can be used for various long-term financial goals such as wealth creation, retirement, children’s education, and marriage. For short-term goals, it is advisable to choose debt mutual funds.

In NPS, your money is invested in different asset classes, including equity, government bonds, corporate bonds, and alternative investment funds. Currently, NPS investors can choose between two investment options: Auto and Active choice. In the Active choice, NPS subscribers can choose the allocation percentage in different asset classes themselves. In the Auto choice, the allocation is done automatically based on your age.

Equity mutual funds invest the majority of their assets in shares of different companies. According to the AMFI, these schemes have to invest a minimum of 65% of the assets in equity and equity-related instruments. Equity mutual funds invest in shares of companies from different sectors/themes and market caps.

NPS is considered safer and less volatile compared to equity mutual funds because they diversify the fund into equity, corporate bonds, and government bonds, while equity mutual funds mostly invest the fund in equity shares, hence there is more concern about volatility.

Investing in a Tier-1 account of NPS comes with a lock-in period until retirement. However, partial withdrawal is allowed from NPS for certain situations like medical emergencies, education, and marriage expenses. On the other hand, except for Equity Linked Savings Scheme (ELSS), most equity mutual fund schemes do not have a lock-in period. ELSS has a lock-in period of three years.

The National Pension System (NPS) is generally used for pension and tax-saving purposes. Investment in NPS qualifies for a deduction of up to Rs. 50,000 under Section 80CCD 1(B) of the Income-Tax Act. If you are salaried and your employer contributes to NPS on your behalf, you can claim a deduction of up to 10% of Basic Salary plus DA under Section 80CCD(2). The limit for government employees is 14%. Investing in NPS on your own qualifies for a deduction under Section 80CCD(1), subject to a cap under Section 80CCE. The combined deduction limit for Section 80C, 80CCC, and Section 80CCD(1) is up to Rs. 1.5 lakh.

Apart from Equity Linked Savings Scheme (ELSS), investing in any other equity mutual fund does not qualify for a tax deduction. Investment in ELSS qualifies for a deduction under Section 80C of the Income Tax Act. The maximum limit for deduction under Section 80C is up to Rs. 1.5 lakh.

In NPS, there is no tax on withdrawing 60% of the total deposited amount in the account at maturity. The remaining 40% has to be used to purchase an annuity plan, which provides regular income. There is no tax on the investment in the annuity plan, but tax may be applicable on the annuity income as per the tax slab.

There is a tax on redemption or withdrawal from equity mutual funds. Investments in equity mutual funds for more than 12 months are considered long-term. Long-term capital gains tax (LTCG) is applicable on withdrawing investments held for more than 12 months. There is no tax on long-term capital gains (LTCG) of up to Rs. 1 lakh in a financial year. Above this, a tax of 10% is applicable. Short-term capital gains tax is applicable if the holding period is less than 12 months. It is taxed at 15%.

Harshad Chetanwala, co-founder of MyWealthGrowth.com, explains that equity mutual funds primarily invest in shares. With a longer investment horizon, the risk in equity funds decreases. In the long term, the return on equity mutual funds can be between 12% to 15%. NPS is more diversified. Even with a maximum equity allocation of 75%, the long-term return of NPS is 2% to 4% lower than equity mutual funds.

Before investing in NPS or equity mutual funds, carefully read the scheme-related documents. Decide after determining your risk appetite and investment goal. Seek advice from a financial planner. If your goal is low risk and decent returns, NPS can work for you in retirement planning. Those willing to take more risk for higher returns can consider equity mutual funds for retirement and other financial goals. However, maintain a long-term perspective in both investments.