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    NPS or retirement funds? Comparison of asset allocation, taxation, cost and liquidity


    The NPS follows an asset allocation-based approach. It offers subscribers the choice of two investing modes—active and auto. With retirement funds, investors are stuck with the same fund manager even though, theoretically, they can opt for multiple retirement funds.

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    Investors have a choice of two dedicated retirement vehicles. A comparative analysis of both indicates which is likely to do a better job of building your nest egg.

    Asset allocation
    The NPS follows an asset allocation-based approach. It offers subscribers the choice of two investing modes—active and auto. Under active choice, you can pick your own asset mix, deciding the split among equity, corporate bonds and government bonds. In auto mode, you can opt for lifecycle funds, where the asset mix changes automatically as the individual grows older. Three lifecycle funds—aggressive, moderate and conservative—cater to investors with different risk appetites. Unlike the NPS, not all retirement funds have a built-in asset allocation mechanism.

    Earlier, retirement funds came in a hybrid flavour, but didn’t offer any flexibility in altering the asset mix. Only the newer retirement funds have come in 3-4 variants or plans that are geared towards different investor profiles. Each plan runs a different asset mix and the investor is free to choose one that is most suited to his own requirements. The investor can switch between plans at a time of his choosing, even during the initial five-year lock-in period, or opt for the auto-switch option, wherein his existing money invested in any plan will be deployed in another plan at a pre-defined date in the future.

    The maximum equity allocation permissible under the NPS is 75%, even as retirement funds allow 100% allocation in a pure equity plan. Yet, the NPS edges out retirement funds in asset allocation for two reasons. First, switches under the NPS do not attract capital gains tax. In retirement funds, investors have to bear tax on any capital gains at every switch. Second, the NPS now allows more flexibility in asset allocation by offering subscribers the choice of different fund managers for each asset class. This lets them pick the best fund manager for each asset class and allows them to switch fund managers once in a year. With retirement funds, investors are stuck with the same fund manager even though, theoretically, they can opt for multiple retirement funds.
    Winner: NPS

    Withdrawals and liquidity
    Theoretically, contributions to tier 1 NPS accounts are locked till the age of 60. It discourages partial and premature withdrawals by placing restrictions. After completion of three years, the subscriber can withdraw up to 25% of his contributions for specific reasons. He can withdraw up to 50% of the corpus if he has completed 25 years of service. A subscriber can partially withdraw up to a maximum of three times during his entire tenure in the NPS. After completion of five years, he can withdraw a maximum 20% of the corpus as a lump sum, and at least 80% of the corpus has to be utilised for purchasing an annuity plan for receiving the pension.

    Only if the accumulated corpus is less than Rs.2.5 lakh is the entire corpus paid as a lump sum to the subscriber. On retirement, only up to 60% of the corpus in the NPS can be withdrawn as a lump sum. The rest has to be directed towards annuity. If the accumulated corpus is less than Rs.5 lakh, the entire corpus is paid as a lump sum to the subscriber. Investors have no choice but to accept the typically poor annuity rates offered by the insurers.

    In the unfortunate event of the death of a subscriber, the nominee/legal heir can withdraw the entire accumulated NPS corpus.

    Meanwhile, retirement funds permit full withdrawal after the mandatory lockin period of five years, or upon retirement, whichever is earlier. Apart from lump-sum withdrawals, a retirement fund allows investors to set up a systematic withdrawal plan (SWP) at the time of retirement so that they can draw a steady stream of cash flow suited to their requirements. It does not force annuity payouts. The corpus that is not withdrawn remains invested, generating more returns for the investor.
    Winner: Retirement funds

    Tax benefits

    The contribution towards retirement mutual funds launched in recent years no longer qualify for a tax break under Section 80C, unlike the earlier schemes. The capital gains during withdrawal are taxed according to the nature of the underlying scheme—equity oriented or nonequity oriented.

    Meanwhile, up to 60% of the NPS corpus withdrawn as a lump sum at retirement is tax-free. The income earned as pension from the annuity portion is taxable at the slab rate. Besides, contributions to the NPS are eligible for tax benefits under three different heads. NPS investments are eligible for deduction under Section 80CCD(1), with an overall ceiling of Rs.1.5 lakh under Section 80C.

    Besides, both salaried and self-employed people can claim an additional deduction of up to Rs.50,000 under the new Section 80CCD (1B). In the 30% tax bracket, this means an additional tax saving of Rs.15,600. Subscribers can claim a combined deduction of up to Rs.2 lakh for contribution to the NPS (under the old tax regime). They can bring down the tax liability further if their employer puts up to 10% of their basic salary in the NPS under Section 80CCD(2). The best part is that this deduction is available under both old and new tax regimes.
    Winner: NPS

    The NPS charges a low fund management expense of only 0.09%, making it a highly cost-effective option. Apart from this, the subscriber pays recurring transaction charges and annual account maintenance charges, which are very reasonable. Retirement funds, on the other hand, are much costlier, charging a recurring expense ratio of up to 2.25%.
    Winner: NPS

    Overall winner: NPS
    With loaded tax benefits, lower expenses and added flexibility in choosing and switching among multiple fund managers, the NPS emerges as the clear winner over retirement mutual funds. However, the forced annuity component, along with limited liquidity, may put off some investors.
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