Retirement planning is a vital aspect of every individual’s life. It involves a careful accumulation of funds that will provide you with the necessary financial resources you would require to meet their post-retirement expenses. The most important aspect of planning for your retirement is to start early and invest in avenues that offer inflation-beating returns.
When it comes to retirement there are two popular routes that individuals look for; the National Pension Scheme and mutual fund SIP. In this blog, I will compare both plans on various parameters so that you can select the one most suitable for you. Read on!
NPS or National Pension Scheme was introduced by the government in 2004. Initially, it was an exclusive scheme available only to government employees.
However, in 2009, NPS in India was made available to employees beyond the public sector. It allows you to invest in the scheme throughout your employment. You can withdraw up to 40% of the accumulated corpus upon retirement.
A portion of the remaining 60% needs to be reinvested in annuity and while the other can be credited monthly.
SIP or Systematic Investment Plan, on the other hand, is a way to invest in mutual funds that allows you to invest periodically in a specific fund and enjoy dividends on your investments regularly.
Mutual Funds are investment pools which accumulate funds from various individuals which is used to purchase securities. These securities can be either market-linked or fixed-income securities. Examples of market-linked securities are equity shares and stocks; debentures, bonds, bills are examples of fixed income securities.
Between NPS and SIP returns, long-term gains from the latter tend to be higher. If you start investing early in a diversified equity portfolio via the SIP route, you would be able to amass a comfortable corpus due to the power of compounding that SIP leverages. SIP route also frees you from the bothers of market timing. You can also choose to invest in fixed income funds, i.e. debt funds which offer considerable returns and involves lower risk compared to equity funds.
Example: Mr. A decides to invest Rs. 500 monthly through SIP in a 14% ELSS fund at the age of 40. He plans to retire at the age of 60 years. Therefore, he avails 20 years for his investment. At the end of 20 years, his total investment amount would stand at Rs. 1.2 Lakh and his returns from the same would be nearly Rs. 6.5 Lakh. In a period of 20 years, his investments appreciated by almost six times.
Tax Implications on NPS and SIP
In case of SIP Mutual Funds, the dividends realized from it are exempt from tax. On the other hand, capital gains on the same are taxed as per the duration of the investment. Capital gains are classified into two categories – long-term capital gains and short-term capital gains. Depending on the kind of Mutual Fund, the duration is determined.
If it is an equity fund or an equity-oriented capital fund, gains from it will be classified as long-term capital gains if the investment tenure exceeds 1 year.
Similarly, if it is a debt fund, debt-oriented hybrid fund, or ELSS fund, then it will be classified as long-term capital gain if the period exceeds 3 years. The following table demonstrates the tax implications of capital gains.
|Particulars||Long-term capital gain tax||Short-term capital gain tax|
|Equity Funds||10% on the amount exceeding Rs. 1 Lakh||15%|
|Debt Funds||20%||Taxed as per the applicable slab rate|
|ELSS funds||10% on the amount exceeding Rs. 1 Lakh||15%|
|Equity-oriented hybrid funds||As per equity fund taxation||As per equity fund taxation|
|Debt-oriented balanced funds||As per debt fund taxation||As per debt fund taxation|
NPS, on the other hand, is tax-free to the extent of 60% of the corpus amount. The rest 40%, which is to be reinvested in annuity, is taxable as per the applicable tax slab of the individual.
Both NPS and SIP for ELSS receive tax benefits u/s 80C.
Gross income from NPS is exempted from tax up to Rs. 1.5 Lakh u/s 80CCE. You can also receive a tax exemption of up to Rs. 50,000 on the NPS investment amount u/s 80CCD.
Similarly, u/s 80C investment amount in ELSS funds is exempted to the extent of Rs. 1.5 Lakh in a year.
The bottom line to choosing the right investment option depends on how fast you want to retire, how long is your investment horizon, the amount of corpus you want to accumulate and ultimately your risk profile. If flexibility and liquidity is an important aspect for you then the SIP route to investing in mutual funds certainly scores over NPS. If you invest in equities via the SIP route, you can even retire early and start receiving a monthly amount by means of a systematic withdrawal plan, which is not in the case of NPS. So weigh the pros and cons of both options and select the one that is most aligned with your needs.
Disclaimer: The views expressed in this post are that of the author and not those of Groww