NPS Tier 2 vs Hybrid Mutual Funds: Where to bet for long-term wealth? (2024)

Mr Amit Sinha, Group Head, Social Security and Welfare, Protean eGov Technologies Limited (formerly NSDL eGovernance Infrastructure Limited)

Retirement planning is a vital aspect of every individual’s life, which involves careful accumulation of sufficient corpus which will provide the individual with the necessary financial resources that would be required to meet post-retirement expenses. The most important aspect of planning for retirement is to start early and invest in avenues that offer inflation-beating returns through Compounding.

National Pension System(NPS) is one such product which caters to one’s long term as well as short term needs. Tier-I is a Pension account which caters to long term needs whereas Tier-II is an investment account for the short term needs. While Tier- II investment is often compared with Mutual funds, Tier-II edges over Mutual funds in certain benefits as detailed below, which makes it more attractive for the Individual investor.

1. The first benefit amongst that is the Low fund management charge, which is also referred to as expense ratio. It is the lowest cost Active Management fund available at a graded expense ratio of 6 basis points.

2. The transactions are executed through a completely digital interface and the respective transaction amount is credited to the Subscribers account in (T+2) days.

3. The second benefit is Liquidity in terms of emergency fund (i.e No lock-in) that the NPS ‘Tier II’ account offers, coupled with flexibility in terms of withdrawal with no exit load levied upon withdrawing the funds.

4. The third benefit is switching from Tier-II to Tier –I . The amount can be switched from Tier-II to Tier – I i.e from an Investment account to a Retirement pot in a seamless manner.

5. Fourth benefit is in terms of flexibility in choice of Investment options and multiple Pension fund managers, which is currently not available under Mutual Funds.

Considering the short-term investment option made available under ‘Tier II’, individuals are allowed to take risk and invest upto 100% assets under Equity option, out of three choices i.e. Equity, Corporate Debt & Government Securities, or alternatively, they may opt for a combination of these choices with a greater equity proportion, similar to large cap ‘Hybrid Funds’.

Accordingly, an investor can take decision based on their Goal, Market knowledge and Investment capacity. NPS is a good option for those looking at a handsome retirement Corpus with higher internal rate of return from both Tier I as well as Tier II accounts. Whereas, Mutual funds suits those looking for a diversified investment pool over an extended period of time.

To summarise, the purposive investment for short-term goals with quick asset liquidity, is what NPS Tier II account can offer an individual. Overall NPS is a product that meets most of the requirement for an individual who is looking at investment plus growth and wealth creation.

Kavitha Krishnan, Senior Analyst – Manager Research, Morningstar India

Mutual funds are pooled investment structures where a skilled portfolio manager manages investors’ money. Mutual funds schemes don’t carry a lock in except for the ELSS schemes. Major advantages in mutual funds include the investor’s ability to pick and choose the fund categories that they want to invest in and build a portfolio based on their investment needs and goals.

NPS Tier II is voluntary in nature and gives its investors the option to choose their asset allocation and fund managers if they want to. Having said that this choice can be applied, keeping in mind certain limits. For example, an investor can opt for a maximum investment of 75% in equity. The Tier II account allows for unlimited investments and redemptions without any exit load subject to an initial investment of INR 1000. This is also a relatively low-cost option in comparison to mutual funds. Having said that, NPS Tier II can only be subscribed to by investors who already hold a NPS Tier I account. Moreover, there are minimum investment limits in the Tier I account which have to be adhered to keep it active.

Investors have largely gravitated toward mutual funds owing to the ease of accessing and managing their portfolios. Moreover, it gives them the capability to invest across asset classes in line with their investment goals. While both the products offer similar benefits, they are some differences, and both the products are positioned differently. Another important point to consider is that these are products that are largely suitable for long-term investing.

Alekh Yadav, Head of Investment Products, Sanctum Wealth

Unlike NPS Tier-1, NPS Tier 2 has no mandatory lock-in period. Just like a mutual fund, these funds can be withdrawn at any time. Also unlike Tier-1, NPS tier-2 has no tax benefit. NPS Tier-2 investors can choose a fund manager from the available options as well as can choose various combinations of asset classes, just Tier-1 investors.

Investors of mutual funds have various options at their disposal. They can choose from a much greater number of fund managers, also various types of funds are available. For example, with equity mutual funds investors can choose a large-cap MF, flexicap MF, midcap MF and so on. Similarly, many categories of debt mutual funds, hybrid and multi-asset mutual funds are also available. Even exposure to international equity is possible via mutual funds. Hence, investors that understand investing and want to build a portfolio using a wide variety of options may prefer mutual funds.

However, having many options is not always a boon. For investors that want to keep it simple, and have limited knowledge and access to financial advisors Tier-2 NPS could be a good option. NPS Tier-2 also provides an auto-choice option for asset allocation for investors that don’t want to manage asset allocation themselves.

Also, the management fee on NPS (both Tier-1 and Tier-2) is very low compared to mutual funds. Thus, the choice of mutual funds vs Tier-2 NPS would vary depending on the investor and requirements.

Mr. Abhishek Dev, CEO and Co-Founder, Epsilon Money Mart

When the talk of NPS comes, we automatically understand we are referring to retirement planning. And retirement planning should be a carefully thought-out strategy. It is a central government retirement scheme regulated by the Pension Fund Regulatory and Development Authority (PFRDA). It offers dual benefits of tax saving plus pension.

However, NPS Tier 2 account is a voluntary account; thus, only subscribers holding Tier 1 accounts can open a Tier 2 account with an initial contribution of Rs. 1,000. Neither does it have a minimum balance requirement, nor does it have any withdrawal restrictions. But the most important feature of NPS investments: tax savings is also not present. Thus, it becomes taxable as per the individual’s income tax slab.

A mutual fund is a pool of money that is professionally managed by a fund manager. It provides a diversified portfolio of stocks, debt, market size, sectors, and industries. They don’t have a lock-in period and are open-ended, thus they offer higher liquidity and are more flexible.

We present different points and leave it for you to decide, which one is better:

a. Allocation: similar to NPS, Mutual funds do also have a mixture of asset classes. However mutual funds to alao offer single asset class fund options to suit different requirements. Thus, you get more options to invest as per your need.

b. Risk: If the risk factor is an important criterion for investment, while NPS stands out over equity mutual funds over short term on risks. However, Debt or Hybrid mutual funds can be tapped into with similar or lower risk profile.

c. Taxation: with no taxation benefits in NPS Tier-2 account, NPS investments is at the same footing. Thus, both willl be taxed equally as per their constituents.

d. ELSS mutual funds: while we can debate the new tax regime, the old regime is still present. Thus, ELSS funds offer tax benefits coupled with the advantage of equity returns. Thus, here mutual funds stand out.

Therefore NPS may be compared with a Hybrid mutual fund. With no tax incentives in Tier-2 account, and long-term returns somewhere around 8-10% in a diversified fund, it depends on the suitability of the investors. Aggressive hybrid funds have over the long term given a return between 10-12% in the past (though past returns are no indication of future performance). Thus, for new investors, looking for retirement planning, investing in plain equity funds can do the trick with the suitable risk profile and investment horizon.

Nidhi Manchanda, Certified Financial Planner, Head of Training, Research & Development at Fintoo

If you are considering NPS vs MF for your retirement savings, it is important to note that NPS offers significant tax benefits only if you choose to invest in a Tier 1 account.

These tax benefits include tax deduction up to Rs. 1.5 lakh per year on NPS contributions under Section 80C of Income Tax Act and an additional deduction of up to Rs. 50,000 per year under Section 80CCD(1B) of the Income Tax Act. At retirement, up to 60% of the accumulated NPS corpus can be withdrawn tax-free.

However, all these tax benefits are not available if you are opting for an NPS Tier 2 account.

Investors who seek flexibility in withdrawals can opt for NPS Tier 2 account as it does not have a lock-in period until retirement, unlike Tier 1 account which has restrictions on withdrawals.

Investors who desire a no lock-in period may also find mutual funds to be a suitable investment option. While NPS Tier 2 account offers flexibility in withdrawals, it is recommended to consider mutual funds instead, as they offer certain advantages over NPS Tier 2 account. These are:

Firstly, investors have a wide range of investment options to choose from, as there are over 40 Asset Management Companies (AMCs) to select from, compared to only around 7 Pension Fund managers available in NPS.

Secondly, mutual funds offer the flexibility to create and execute a retirement investment strategy, as all asset classes are available for investment. This includes exposure to gold, as well as the ability to invest as per one's risk profile. Additionally, aggressive investors can take sector-specific exposures in mutual funds.

Thirdly, investors can review and rebalance their portfolio as per their needs without any restrictions.

Lastly, investors can also consider investing in Equity Linked Saving Scheme (ELSS) mutual funds for retirement planning, which offers tax benefits and is liquid after 3 years but investors can stay invested till retirement.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.

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Published: 26 Feb 2023, 10:29 PM IST