NPS Tier 2 account is an optional savings account tailored for retirement savings, while mutual funds are investment vehicles that offer extensive investment options for varied investment goals.
Several investors seeking to maximise returns find themselves mulling the MF vs NPS Tier 2 debate quite frequently. To help you make an informed choice, we discuss the NPS Tier 2 vs mutual fund dilemma in detail below.
What is NPS Tier 2?
An NPS Tier 2 account is a voluntary savings account open to Tier 1 subscribers. Tier 2 accounts can be activated with a minimum investment of Rs. 1,000. Funds can be deposited and withdrawn at your convenience. There are no exit fees or minimum balance requirements pertaining to Tier 2 accounts. However, no tax benefits are available for investments made in Tier 2 accounts.
Like Tier 1 accounts, you can choose from the Active and Auto Choice options to manage asset allocation. Under the Active Choice option, you can construct a portfolio based on your market knowledge and risk appetite. However, your portfolio’s equity exposure can be a maximum of 75% up to the age of 50. Thereafter, equity exposure decreases by 2.5% every year, reaching 50% at the age of 60 years. The Auto Choice option auto-allocates your investment based on your age and the selected investment approach (aggressive, moderate, or conservative).
What are mutual funds?
Mutual funds are a type of investment instrument that pools money from investors with a shared investment objective. These pooled funds are invested under the guidance of professional fund managers into a variety of assets like stocks, bonds, and other securities. The fund’s per unit value is based on its NAV (Net Asset Value) which is calculated daily. You can buy or redeem MF units at the current NAV.
Mutual funds are regulated by SEBI and offer investors with different risk appetites an easy way to diversify their investments. Since investments can be started on an SIP basis with a nominal amount of just Rs. 100, mutual funds offer the benefit of investing funds in a professionally managed diversified basket of securities without requiring a sizable deposit. Read more about, What is a mutual fund.
Differences between NPS Tier 2 and mutual funds
Let’s assess the NPS Tier 2 vs. mutual funds debate in detail:
Parameter |
NPS Tier 2 |
Mutual Funds |
Objective |
Retirement savings |
Wealth creation |
Type |
Voluntary savings account linked to a pension product |
Investment product |
Regulating authority |
PFRDA |
SEBI |
Minimum investment |
You need to make a minimum initial contribution of Rs. 1,000 |
You can start MF SIP investments with a nominal contribution of Rs. 100 |
Asset allocation |
The Active Choice option allows you to tailor your portfolio according to your risk tolerance levels and invest in government bonds, equity, corporate debt, and alternative funds. The Auto Choice option is best for those with limited time and knowledge about portfolio management. Your contributions are invested in equity, government bonds, and corporate debt based on your age. Based on your risk appetite, you can choose from Aggressive, Moderate, and Conservative options. |
Equity MFs invest at least 65% of their assets in equity stocks, while debt funds invest the corpus in fixed-income assets like bonds. Hybrid funds include both equity and debt investments. |
Lock-in period |
No lock-in period. |
Generally, MFs do not have a mandatory lock-in period. However, exiting the fund before a certain time period (usually 1 year) requires exit load payment. Only ELSS mutual funds impose a 3-year lock-in period on SIP and lump-sum investments. |
Tax benefits on contributions |
No tax benefits on NPS Tier 2 contributions |
Contributions to ELSS mutual funds qualify for tax deductions of up to Rs. 1.5 Lakhs u/s 80(C) |
Tax benefits on withdrawals and maturity |
Withdrawals are added to your total income and taxed as per the applicable income tax slab |
Capital gains from MFs are taxed according to the fund type and holding period. A short-term capital gains tax of 15% is applicable on equity funds held for less than a year. If the holding period is more than a year, gains of up to Rs 1 Lakh are tax-free. From April 1st 2023 onwards, all capital gains from debt funds are taxed as per the applicable income tax slab. Taxation on hybrid funds is dependent on the portfolio’s equity exposure. |
Exit load |
Withdrawal of funds without exit loads |
Exit loads apply if funds are withdrawn before the end of a stipulated term (generally 1 year) |
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Which is better between NPS Tier 2 vs. mutual funds?
In a mutual fund vs. NPS Tier 2 head-to-head comparison, both present certain pros and cons. For NPS investments, the equity exposure of your portfolio is determined by age. Even under the Active Choice option, equity exposure is capped at up to 75% and progressively lowered with age. This conservative approach can result in lower returns than equity-oriented MFs. Alternatively, for MF investments, you can choose mutual fund schemes and decide on the equity exposure of your portfolio based on your investment goals and risk appetite.
You can enjoy a greater degree of flexibility with MF investments, investing in different types of funds like equity, hybrid, small-cap, mid-cap, or sector-specific MFs. You can stay invested in the funds for as long as you wish and earn returns. In fact, pure equity funds have a higher potential for gains as compared to NPS Tier 2 accounts. However, when it comes to investment costs, NPS Tier 2 accounts edge over MFs where the expense ratio is much higher than the applicable NPS fund management fees.
Who should invest in NPS Tier 2 over mutual funds?
In the NPS Tier 2 vs. mutual funds debate, you should choose an NPS Tier 2 account if:
- You are curating a retirement plan and already have an NPS Tier 1 account.
- You need a liquid investment account without extra annual maintenance charges, minimum balance requirements, and exit loads.
- You prefer a low-cost account with nominal fund management charges (expense ratio).
- You have limited market knowledge and require auto asset allocation (Auto Choice option).
Who should invest in mutual funds over NPS Tier 2?
You should opt for mutual funds over NPS Tier 2 accounts if:
- You are willing to shoulder a higher risk for potentially higher returns.
- You are looking for flexible investment options and a portfolio without equity exposure caps.
- You wish to make goal-based investments and select from different fund options.
- You prefer a tax-efficient investment avenue (only ELSS funds).
List of low risk mutual funds to invest in 2024
- Canara Robeco Bluechip Equity Fund
- ICICI Prudential Value Discovery Fund
- Kotak Bluechip Fund
- Nippon India Large Cap Fund
- HDFC Index Fund-NIFTY 50 Plan
Conclusion
In conclusion, when it comes to the mutual funds vs. NPS Tier 2 debate, you cannot use a one-size-fits-all approach. Each investor has different investment goals, time horizons, risk appetites, and investment capacities. If you are looking for secured and less volatile retirement planning with no extra annual charges, Tier 2 accounts may be the better choice. Alternatively, if you don’t mind shouldering higher risks for potentially higher returns, equity-focused MFs may be the better option.
You can start your MF investments on the Bajaj Finserv Mutual Fund Platform. On this digital platform, you can compare mutual funds and choose from 1000+ fund options to tailor a portfolio that fits your financial goals and risk appetite.
