NPS vs Mutual Funds: Where Should You Invest for Best Returns?

April 16, 2025 By: Naresh Saini

When planning for long-term wealth creation, two popular options dominate Indian investors’ minds – the National Pension System (NPS) and Mutual Funds. Both offer distinct advantages, but which one suits your financial goals better?

• NPS is a government-backed retirement scheme with tax benefits and fixed asset allocation.
• Mutual Funds are market-linked investments offering flexibility, higher returns, and liquidity.

This in-depth comparison will help you decide where to invest based on returns, risks, liquidity, tax benefits, and long-term growth.

What is NPS?

The National Pension System (NPS) is a long-term retirement-focused investment scheme regulated by PFRDA (Pension Fund Regulatory and Development Authority).

Key Features of NPS:

✔ Tax Benefits: Up to ₹2 lakh under Sec 80C, 80CCD(1B)
✔ Low-Cost Investing: Fund management charges (~0.01%)
✔ Fixed Asset Allocation: Equity (max 75%), Debt, and Govt. Bonds
✔ Annuity Compulsion: At least 40% corpus must be used to buy a pension plan at maturity
✔ Lock-in Till Retirement: Partial withdrawals allowed after 10 years

Best For: Risk-averse investors seeking a disciplined, tax-efficient retirement plan.

What Are Mutual Funds?

Mutual funds pool money from multiple investors to invest in stocks, bonds, gold, or other assets based on the fund’s objective.

Key Features of Mutual Funds:

✔ Diverse Options: Equity, debt, hybrid, ELSS, SIP/Lumpsum
✔ Higher Return Potential: Equity funds historically give 10-12% CAGR
✔ Liquidity: Open-ended funds allow anytime redemption (except ELSS)
✔ No Annuity Compulsion: Full withdrawal at maturity
✔ Taxation: LTCG on equity (10% above ₹1L), STCG (15%)

Best For: Investors seeking wealth creation with flexibility and market-linked returns.

NPS vs Mutual Funds – Detailed Comparison

Factor	NPS	Mutual Funds
Returns	8-10% (balanced)	10-14% (equity funds)
Liquidity	Lock-in till 60, partial exit after 10 yrs	No lock-in (except ELSS)
Tax Benefits	₹2L (80C + 80CCD)	₹1.5L (ELSS under 80C)
Risk	Moderate (fixed allocation)	High (market-linked)
Withdrawal Rules	60% tax-free, 40% annuity	Fully redeemable (tax applies)
Expense Ratio	0.01-0.1% (lowest in India)	0.5-2.5% (higher for active funds)

Which One Performs Better?

• For Retirement Planning: NPS (due to tax benefits & discipline)
• For Wealth Creation: Mutual Funds (higher returns & liquidity)

Tax Implications: NPS vs Mutual Funds

NPS Tax Benefits:

• Investment Deduction: ₹1.5L (80C) + ₹50K (80CCD(1B))
• Maturity: 60% tax-free, 40% annuity (taxable)

Mutual Fund Taxation:

• Equity Funds:
  • STCG (15% if sold <1 year)
  • LTCG (10% above ₹1L profit)
• Debt Funds:
  • STCG (as per income slab)
  • LTCG (20% with indexation)

Verdict: NPS offers better tax efficiency, but mutual funds provide more liquidity post-retirement.

Liquidity & Withdrawal Rules

NPS:

🚫 Strict Lock-in: Withdrawals only after age 60 (or extreme cases)
🔄 Partial Withdrawal: Allowed after 10 years (specific conditions)

Mutual Funds:

💳 No Lock-in (Except ELSS): Redeem anytime (exit load may apply)
💰 Systematic Withdrawal Plan (SWP): Regular income possible

Winner: Mutual funds for emergency fund needs.

Which Should You Choose? Final Verdict

Invest in NPS If You:

✔ Want a low-cost, disciplined retirement plan
✔ Need extra tax savings beyond 80C
✔ Can tolerate moderate returns for safety

Invest in Mutual Funds If You:

✔ Seek higher returns (10%+ CAGR)
✔ Prefer liquidity & flexibility
✔ Are okay with market risks

Ideal Strategy? Combine Both!

• Use NPS for retirement corpus + tax savings
• Use mutual funds (SIPs) for wealth creation

Conclusion: NPS for Safety, Mutual Funds for Growth

While NPS ensures a tax-efficient retirement, mutual funds offer better growth potential. Your choice depends on:

🔹 Risk Appetite (Safe vs Aggressive)
🔹 Liquidity Needs (Lock-in vs Flexible)
🔹 Tax Planning (NPS vs ELSS)

Pro Tip: Diversify! Allocate to NPS for retirement and equity mutual funds for long-term wealth.