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NPS Tier 2 account is purely an optional account. Only customers with NPS Tier 1 accounts are eligible to open a Tier 2 account. Four asset types are available in the NPS Tier 2 account: stock, government securities, corporate bonds, and alternative investment funds. On the other hand, mutual funds are a type of investment instrument that pools money from multiple investors to invest in assets such as stocks and bonds. A mutual fund makes strategic investments in stocks, bonds, government securities, and other assets. This article highlights the key differences between NPS Tier 2 Vs Mutual Fund.

Difference Between NPS Tier 2 and Mutual Fund

Basis of DifferenceNPS Tier 2 AccountMutual Fund
Minimum InvestmentThe minimum investment amount for opening Tier 2 Account is INR 1,000.You can start mutual fund SIP investments with as low as INR 500.
TypesAuto Choice and Active ChoiceEquity, Debt, Hybrid, Gold, and Index
Asset AllocationActive Choice: You can choose to invest in a government bond, corporate debt, or other assets.Until you reach the age of 50, the maximum equity allocation is 75% of the overall portfolio value.The maximum allowed equity proportion thereafter decreases by 2.5% per year until it reaches 50% at the age of 60.
Auto Choice: It is a suitable option for those with inadequate knowledge of managing their investment allocation. Under auto choice, you can choose from three fund types: Moderate Life Cycle Fund, Conservative Life Cycle Fund, and Aggressive Life Cycle Fund. All of these have a maximum equity cap of 75%, 50%, and 25%, respectively, until you reach the age of 35. Following that, as age increases, the equity in the asset allocation decreases.
Equity: Equity mutual funds invest at least 65% of their assets in equity and equity-related securities.
Debt: Debt mutual funds invest their corpus across fixed income securities.
Hybrid: Hybrid mutual funds adjust the fund’s portfolio based on market conditions. They actively managed the funds between both equity and debt instruments.
Lock-In PeriodNo Lock-in Period. However, there is a three year lock-in period for central government and state government employees if they wish to avail tax benefits.Mutual funds do not have any lock-in period, except for ELSS mutual funds. However, mutual funds have an exit load for withdrawing before one year.
ReturnsHistorical average returns are in the range of 9% to 12%.Equity mutual funds have the potential to outperform the NPS over time. Historically, the equity assets class has given a substantially higher return than any other asset class.
Tax Exemption on InvestmentsNPS Tier 1 investments are eligible for tax deduction under Section 80C. However, Tier 2 account investments are not eligible for any tax deductions because it is a voluntary account.Only Equity Linked Savings Schemes (ELSS) funds qualify for tax exemption under Section 80C of the Income Tax Act, 1961. No other mutual funds have any tax exemptions.
Taxation on Withdrawals and MaturityYou can withdraw the entire Tier 2 NPS account corpus as a lump sum or multiple withdrawals without any limit. Moreover, the withdrawals are added to your total taxable income. They are taxed according to your income tax bracket.Capital Gains from mutual funds are taxable. The taxation depends on the type of mutual funds and the investment holding period.
Equity Mutual Funds: If the holding period is less than one year, the capital gains are taxable at Short Term Capital Gains rate of 15%. On the other hand, if the holding period is more than one year, then the capital gains up to INR 1,00,000 are tax-free. For gains more than INR 1,00,000, the Long Term Capital Gains Tax is 10%.
Debt Mutual Funds: If the holding period is less than three years, the short term capital gains are taxable as per your income tax slab rates. On the other hand, if the holding period is more than three years, the capital gains are taxable at the Long Term Capital Gains Tax rate of 20% with indexation benefit.
LiquidityYou can easily transfer funds from an NPS Tier 2 account to NPS Tier 1 account. Since there is no lock-in period for NPS Tier 2 accounts, you can easily redeem your investments.Mutual fund investments are highly liquid. You can redeem your fund units anytime.

NPS Tier 2 Vs Mutual Fund – Which is Better?

To open an NPS Tier 2 account, you need to have an NPS Tier 1 account. Thus making NPS Tier 2 accounts a voluntary scheme. NPS Tier 2 account is suitable for retirement. The account has no lock-in period, and the investment allocation can be between active choice or auto choice. The exposure to debt and equity is strategically allocated based on your age. In other words, as your age increases, the equity allocation in your portfolio reduces.

On the other hand, with Mutual Funds, you can choose the type of fund based on your risk tolerance levels. For example, equity mutual funds are suitable for investors with high-risk tolerance levels. Whereas debt mutual funds are suitable for investors with low-risk tolerance levels. Hybrid mutual funds give you the benefit of both the worlds of equity and debt, where the investments are strategically managed between both asset classes.

Mutual fund investments can either be short-term or long-term, depending on the type of fund you choose. Thus, these investments are suitable for goal-based investing. Investing through mutual funds gives you an opportunity to choose a fund that you wish to invest in and hold them as long as you wish. Furthermore, pure equity funds have the capacity to generate higher returns than NPS investments.

Thus, depending on your investment objective and fund choice, you can pick a suitable scheme for your investment.


Most investors are often unsure which option is best for them: NPS Tier II Account or Mutual Funds. There are numerous options accessible in the market for both categories, making it crucial to select one that meets your needs and goals. One size does not fit all when it comes to investing. Everyone has their own set of goals, aspirations, and financial resources. Equity mutual funds are a better choice for capital growth.

If you want to build a retirement fund with regular investments over the long term, NPS is the way to go. However, before concluding your choice, you conduct an extensive study and analyse both the investment options.