Saachi has only one new year’s resolution and that is to stop making excuses and start investing. She has been working for three years now and is no longer able to be a part of dinner conversations with her friends because somehow the conversations have shifted from ‘Did you watch that new movie?’ to ‘Did you invest in that mutual fund yet?’ Like her friends, Saachi wants to start taking care of her financial health and while she doesn’t know much about investments, she is ready to take the leap. So, at dinner tonight at her friend Hrishi’s house, she surprises everyone when she blurts, “Guys, NPS or SIP, which is better?”

“I’m sorry, what? Did Saachi just name drop investments?” Hrishi asks, laughing.

Manya punches Hrishi in the shoulder and says, ‘You’re finally thinking about investing? That’s a really cool way to start this year!”

Saachi rolls her eyes at Hrishi and turns to Manya, “Yes, but I can only invest in small amounts at the moment.”

“Well then, both the national pension system and the systematic investment plan in mutual funds are a good option,” Manya replies.

“That’s how far my research got me but now you need to help me pick. I’m ready to commit to a long-term investment because I’d like to start building wealth as you all always keep saying.”

“In that case, an extra piece of strawberry cheesecake for you,” Manya says as she serves the last bit of dessert to Saachi and continues, “So here’s everything you need to know about SIP vs NPS.”

An overview of NPS and SIP

The NPS scheme is a government-sponsored social security scheme that is primarily used for retirement planning and tax-saving. Any Indian resident or Non-Resident Indian (NRI) between the ages of 18 and 70 can open an NPS account. The maximum age until when an investor can stay invested in NPS is 75.

An SIP is one of the modes of investing in a mutual fund investment that allows you to invest small amounts regularly over a period of time. For instance, Rs. 500 every month for seven years. An SIP allows you to reap all the benefits of a mutual fund investment such as diversification, good returns, liquidity, etc. while investing at your own pace with low amounts that you can comfortably fit in your monthly budget.

NPS vs SIP: Where is the money invested?

The NPS account money is invested across four asset classes – equity, corporate debt, government securities, and alternate investments. The asset allocation between these asset classes depends on whether you opt for the active investment choice or the auto investment choice.

In the active choice, you get to decide the asset classes and proportions subject to certain limits. For instance, the maximum equity investment can be up to 75% till the age of 50. After this, the maximum equity investment limit keeps decreasing with the investor’s age. The maximum allocation for alternate funds is 5%. The active choice is ideal for investors who want more control over their NPS investment and have enough knowledge to make strategic decisions. Conversely, in the auto choice, there is a predefined proportion for asset allocation that is based on the investor’s risk tolerance and age.

There is a Pension Fund Manager (PFM) who handles NPS investments on behalf of the investors. Currently, there are eight PFMs registered with the Pension Fund Regulatory and Development Authority (PFRDA).

As for SIP in mutual funds, you can select between equity funds, debt funds, balanced funds, and Equity-Linked Savings Scheme (ELSS) funds. Equity mutual funds invest primarily in equity and equity-linked instruments while debt funds invest in fixed-income securities such as treasury bills, bonds, corporate debt, etc. Balanced funds invest in both equity and debt instruments while ELSS funds are equity mutual funds but with tax benefits.

How much are you required to invest in NPS vs SIP?

The national pension system has two types of accounts – tier l and tier ll. The NPS tier l account is the default non-withdrawable retirement account while the tier ll account is a voluntary account that has no lock-in period or tax benefits. At the time of opening your tier l account, the minimum contribution required is Rs. 500 and for tier ll it is Rs. 1,000. There is also a minimum yearly contribution of Rs. 1,000 and Rs. 250 for your tier l and tier ll accounts respectively. There is no maximum limit on how much you can invest in the national pension system.

With SIP in mutual funds, one of the major benefits is that it allows you to start investing with as little as Rs. 100. The SIP amount and SIP frequency are flexible, and you can choose what will best suit you. There is also the option of a step-up SIP in which you can increase your SIP amount at certain intervals by a specific percentage or amount. This allows you to increase your SIP investment as your income increases and helps meet your financial goals quicker.

What kind of returns can be expected in NPS vs SIP?

The type of mutual fund you select and the asset allocation you opt for in your national pension system will significantly determine the returns you earn. Let’s look at the 1-year, 3-year, and 5-year returns of NPS vs SIP to get an idea.

NPS returns by asset class

Here are the weighted-average returns of NPS tier l account:

SIP returns by types of mutual funds

Here are the returns of CRISIL 4 and 5-star rated mutual funds of different categories:

Tax benefits and tax treatment of NPS vs SIP

The national pension scheme does have an upper hand when it comes to tax benefits compared to SIP in mutual funds. That’s because only one type of mutual fund has tax benefits and that’s ELSS. Here’s an overview of the tax benefits of NPS vs SIP in ELSS mutual funds:

• Both NPS and SIP in ELSS funds are eligible for tax deduction of up to Rs. 1.5 lakh under section 80C of the Income Tax Act, 1961.
• NPS has an additional deduction of Rs. 50,000 under section 80CCD(1B).
• You can claim another deduction for your NPS investment under section 80CCD(2) if your employer contributes to your national pension system account. This deduction is equal to 10% of your salary (14% for government employees).

As for the tax on SIP vs NPS, the corpus on NPS is tax-free up to 60%. That’s because at the time of maturity, you are required to invest 40% of your corpus in an annuity scheme if your corpus is more than Rs. 5 lakh. The annuities you will receive are taxable and so, indirectly, 40% of your NPS corpus is taxable as per your income tax slab rate.

For SIP in mutual funds, capital gains from equity funds and ELSS funds are taxed at 15% if they are Short-Term Capital Gains (STCGs) and 10% if they are Long-Term Capital Gains (LTCGs). Gains on equity funds held for less than 12 months are STCG while those held for more than 12 months are LTCGs. LTCGs on equity funds do have an exemption of up to Rs. 1 lakh. For debt funds, STCGs are gains from mutual funds held for less than 36 months and are taxed at 20%. Gains from debt funds held for over 36 months are LTCGs and are taxed as per your income tax slab rate. It’s important to note that LTCGs in debt funds allow for indexation benefit.

Lock-in period and early withdrawals

Like with all other tax-saving instruments, both NPS and ELSS mutual funds come with a lock-in period. The NPS lock-in period is up to the age of retirement i.e., 60. While this may sound like a long time, and it is, there are allowances for partial withdrawals for specific emergencies such as treatment of critical illness, children’s higher education and wedding, etc. A maximum of three withdrawals are allowed throughout your NPS scheme tenure and the amount can’t exceed 25% of your NPS investment.

There is also an option for premature withdrawal for which you need to have been an NPS scheme subscriber for a minimum of 10 years. In the case of a premature withdrawal, you are required to invest 80% of your national pension scheme corpus in an annuity scheme if it is more than Rs. 2.5 lakh. ELSS mutual funds don’t have allowances for such premature or partial withdrawals. However, the lock-in period is only three years. This is an advantage not only in the case of NPS vs SIP but also over other tax-saving instruments such as PPF, NSC, etc.

NPS or SIP: Which is better?

An SIP allows you to meet a wide range of financial goals – both short-term and long-term – if you strategically choose the right type of mutual fund. These goals can include saving for your first home, funding your higher education, and even building a retirement corpus. There is flexibility and the advantage of liquidity when it comes to SIPs. NPS, on the other hand, is a long-term investment with the primary focus of saving for your retirement. It’s beneficial to have both an NPS account in place as well as some SIP mutual fund investments in your portfolio. That’s because instead of picking SIP vs NPS, you can use both investments together to effectively meet your financial goals.