Thursday, March 26, 2015

Product Review--NPS or Mutual Fund Retirement Plans

Can I afford to retire?

It's a question that starts haunting people after they are on the wrong side of 40: will they have enough money to live in comfort after retirement? If one starts early, invests regularly and chooses the right investment mix, there is no reason to be worried. However, these simple tenets are rarely followed by investors in India. Retirement planning typically starts in the 40s and low-yield options like bank deposits, PPF and life insurance policies form the biggest chunk of retirement savings. Stocks and equity-oriented funds make do with crumbs.

Union Budget 2015-2016 announced additional Deduction of Rs. 50,000 under section 80CCD for investment in New Pension Scheme. This is over and above current Rs. 1 lac limit available under section 80C. Those in 30% tax bracket will now be able to save Rs. 15,450 on investing Rs. 50,000 in NPS.

NPS might move up the popularity charts, but investors should not ignore the retirement plans from Mutual Funds.

So, how are the retirement funds from Mutual Funds and NPS different?

Asset Allocation

Existing Mutual Fund retirement plans:-
1.    Franklin Pension Plan; and
2.    UTI Retirement benefit pension  fund

invest up to 40% in equity.  Equity exposure under NPS is capped at 50%, and it reduces by 2% annually after age 35, such that by the time the investor reaches the age of 55, only 10% remains in equity. This may not be suitable for a young entrant who wants a higher equity exposure (which is desirable also). Reliance MF has recently launched its own Retirement fund which can invest 65 to 100% of the corpus in equities.  

While NPS restricts the equity component to Nifty50 stocks in the same proportion as their weight in index. MF retirement funds do not have such restriction. Restricting the equity component to Nifty 50 stocks can impact the overall fund performance should the mid cap segment run ahead, as large cap funds are not expected to clock above normal returns. However, the bright side of this is that the NPS portfolio will be less volatile.


NPS is currently the lowest cost pension product available. While NPS charges 0.01%, MF charges anywhere between 2.25—2.50% However, considering the superior performance generated by MF, the charges may well be justified.

The biggest drawback of NPS is that it is subject to EET (i.e., exempt on investment, exempt on accumulation while taxable on withdrawals) regime i.e., withdrawals are fully taxable at the age of 60. (the entire corpus is added to the  income)

Debt oriented MF pension plans will be taxed at 20%( that too only on the returns part) However with indexation, the tax liability reduces significantly. Withdrawals from Equity oriented MFs are, on the other hand, completely tax free—provided the holding period of 1 year has been met.

Furthermore, the pension income is also taxable.

KYA Karein? (What to do)

Those under 30 will be better off with equity oriented MF retirement plans, as the equity component is much higher.

We believe that the existing debt oriented MF score over NPS for those close to retirement, due to higher equity component.