Planning your retirement is among the most crucial financial steps you will take during your lifetime. It requires only one thing โ to accumulate a fund which can sustain you comfortably after you have retired. The trick to successful retirement planning lies in starting early and making the right investment choices to conquer inflation and grow the fund over time.
Regarding retirement plans in the Indian context, two usual alternatives are the National Pension Scheme and the Systematic Investment Plan in mutual funds. Each one has its advantage, but which one to choose? Itโs time to compare the National Pension Scheme and the Systematic Investment Plan based on many parameters, in simple words, to make the best decision.
What is the National Pension Scheme (NPS)?
The National Pension Scheme was launched by the government in 2004, initially for government employees only. In 2009, it was opened to all Indian citizens. NPS allows you to invest regularly during your working years and build a retirement corpus. When you retire, you can withdraw up to 40% of the accumulated amount as a lump sum, while the remaining 60% must be used to buy an annuity that provides monthly pension income.
Features of NPS
#1. Investment Flexibility
One of the benefits of NPS is that you can invest whenever you want. There’s no strict rule that requires you to invest every month, giving you flexibility based on your cash flow.
#2. Low Risk
NPS has limited exposure to equities, with a maximum of 75% allowed in equity investments. This makes it less volatile compared to pure equity funds. However, this also limits the scheme’s potential for high returns.
#3. Investment Options
NPS offers two main investment approaches:
- Active Choice: You decide where to invest based on your risk appetite.
- Auto Choice: The fund manager allocates your money based on your age. As you get older, the allocation automatically shifts toward safer debt instruments.
#4. Returns
Since NPS has limited equity exposure, the returns typically range between 8% to 10% annually. While this is better than traditional fixed deposits, it’s lower than what equity mutual funds can potentially deliver over the long term.
#5. Early Withdrawal Restrictions
NPS has strict rules on early withdrawals. You can only withdraw 25% of your corpus before retirement, and that too only for specific reasons like medical emergencies, children’s education or marriage, or buying a house. You’re allowed only 3 such withdrawals during the entire tenure, with a minimum gap of 5 years between each.
What is a Systematic Investment Plan (SIP)?
A Systematic Investment Plan is a method of investing in mutual funds where you invest a fixed amount regularlyโmonthly, quarterly, or annually. SIPs allow you to build wealth gradually and benefit from the power of compounding. You can choose from various types of mutual funds depending on your risk appetite and goals, including equity funds, debt funds, or hybrid funds.
Features of SIP
#1. Periodic Investments
With SIP, you invest a fixed amount at regular intervals. This builds financial discipline and makes investing a habit. You can start with as little as โน500 per month, making it accessible to almost everyone.
#2. Power of Compounding
SIP investments benefit from compounding, where your returns generate further returns over time. The longer you stay invested, the more your money grows exponentially.
Example: Mr. A invests โน500 monthly through SIP in an ELSS fund offering 14% returns, starting at age 40. By the time he retires at 60, his total investment of โน1.2 lakh would grow to approximately โน6.5 lakhโnearly 6 times his investment.
#3. Rupee Cost Averaging
When markets are down, your fixed SIP amount buys more units. When markets are up, it buys fewer units. Over time, this averaging reduces your overall cost per unit and helps you ride out market volatility without worrying about timing the market.
#4. Higher Returns
Equity mutual funds have historically delivered returns in the range of 14% to 18% over the long term, significantly higher than NPS. While this comes with higher risk and market volatility, the potential for wealth creation is much greater.
#5. Multiple Options
SIPs offer a wide variety of mutual fund options:
- Equity Funds: For long-term wealth creation with higher risk.
- Debt Funds: For stable returns with lower risk.
- Hybrid Funds: A mix of equity and debt for balanced growth.
- ELSS Funds: Equity funds with tax benefits under Section 80C.
This variety allows you to tailor your portfolio to your specific retirement goals and risk tolerance.
#6. Easy Investment Process
Setting up a SIP is simple. You link your bank account, set up an auto-debit mandate, and your investments are automatically debited on the chosen date every month. No hassle, no paperwork after the initial setup.
#7. Withdrawal Flexibility
Unlike NPS, most mutual funds (except ELSS, which has a 3-year lock-in) can be withdrawn anytime without restrictions. You can also set up a Systematic Withdrawal Plan (SWP) after retirement to receive regular monthly income from your accumulated corpus.
Tax Implications: NPS vs SIP
Tax Benefits on Contributions
Both NPS and ELSS mutual funds offer tax deductions under Section 80C up to โน1.5 lakh per year. Additionally, NPS offers an extra deduction of up to โน50,000 under Section 80CCD(1B).
Tax on Withdrawals and Returns
| Particulars | Long-term Capital Gain Tax | Short-term Capital Gain Tax |
|---|---|---|
| Equity Funds | 10% on gains above โน1 lakh | 15% |
| Debt Funds | 20% with indexation benefit | As per income tax slab |
| ELSS Funds | 10% on gains above โน1 lakh | 15% |
| NPS | 60% of corpus is tax-free; remaining 40% (annuity) taxed as per slab | – |
With SIP in equity funds, dividends are tax-free, and you get tax-efficient long-term capital gains. In NPS, 60% of the corpus is tax-free, but the annuity income from the remaining 40% is taxable.
NPS vs SIP
| Feature | NPS | SIP in Mutual Funds |
|---|---|---|
| Investment Flexibility | High | High |
| Returns | 8%-10% | 12%-18% (equity funds) |
| Risk | Low to Moderate | Moderate to High |
| Liquidity | Low (strict withdrawal rules) | High (can withdraw anytime, except ELSS) |
| Tax Benefits | โน1.5 lakh (80C) + โน50,000 (80CCD) | โน1.5 lakh (80C for ELSS) |
| Withdrawal at Retirement | Only 40% lump sum; 60% as annuity | 100% flexible withdrawal or SWP |
| Early Retirement | Not possible | Possible with SWP |
Which is Better: NPS or SIP?
The answer depends on your financial goals, risk appetite, and retirement timeline.
Choose NPS if:
- You want a government-backed, low-risk retirement plan.
- You’re looking for additional tax benefits beyond Section 80C.
- You prefer a structured, disciplined approach with limited equity exposure.
Choose SIP in Mutual Funds if:
- You want higher returns and are willing to take moderate risk.
- You value flexibility and liquidity in your investments.
- You want the option to retire early and set up a systematic withdrawal plan.
- You prefer full control over your corpus without annuity restrictions.
The Bottom Line
To build a stable debt fund portfolio, an investor needs research, time, and proper understanding of his/her objective. Start working on a plan, invest on the basis of his/her risk tolerance, and ignore any suggestions of very high growth.
It is always important to remember that debt mutual funds are never risk-free investments. They require proper planning and proper fund selection for achieving good returns. Your investment time and the type of debt funds you have will help you create a debt investment that will provide you with assured returns.
Learn More:
- How to Start Investing in Mutual Funds in India โ Step-by-Step Process for Beginners
- Difference Between Mutual Funds and Stocks โ Which is Better for Beginners?
- Understanding NAV (Net Asset Value) in Mutual Funds โ What It Means and Why It Matters
- Risks Involved in Mutual Fund Investments โ Common Risks and How to Manage Them
Disclaimer: This blog is for educational purposes only. The securities/investments mentioned here are not recommendations. Please consult a financial advisor before making investment decisions.
