NPS vs SIP

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National Pension Scheme is a social security initiative introduced by the Central Government of India. A systematic Investment Plan (SIP) is an investment route for mutual funds and shares. It allows investors to invest a small and fixed amount of money at regular intervals. Both NPS and SIP serve different investor needs. However, one needs to know which one to choose and when. This article covers NPS, SIP, their benefits and NPS vs SIP in detail.

NPS vs SIP – Difference Between NPS and SIP

The following table lists the differences between NPS vs SIP.

Basis of Difference	NPS	SIP
Average Returns	8% to 10%	10% to 12% (long term)
Lock-in Period	Till retirement	No Lock-in (However, ELSS funds have a three year lock-in period)
Tax Benefits	INR 1,50,000 under Section 80CAdditional INR 50,000 under Section 80CCD.	Only ELSS investments up to INR 1,50,000 qualify for tax benefits.
Risk	Lower risk in comparison to Mutual Funds	Investments are subject to market risks.
Equity Exposure	50% to 75%	It depends on the fund type (Max is 100%).
Minimum Investment Amount	INR 6,000	INR 500
Maximum Investment Amount	No Limit	No Limit
Investment Duration	Until Retirement	No fixed limit
Premature withdrawal	Only 20% of the corpus amount before retirement.	No restrictions can be redeemed anytime.
Taxation	The pension amount is completely tax-free.	Returns are subject to capital gains (STCG and LTCG).

Check Out NPS vs PPF

What is National Pension Scheme (NPS)?

The National Pension Scheme (NPS) is a voluntary retirement plan suitable for a long term investment horizon. The Pension Fund Regulatory and Development Authority (PFRDA) and the Central Government regulate the scheme. Private, Public, and employees of the unorganised sectors can be part of the pension programme. However, armed forces employees are not eligible to subscribe to the scheme.

The National Pension Scheme encourages individuals to start saving much before their retirement. Investors can withdraw a percentage of their accumulated corpus and invest the rest in an annuity on retirement. The remainder is received every month as a pension (annuity). Annuity service providers have to be emplaned with PFRDA to be able to provide services to NPS subscribers. The investor can pick from a range of annuity schemes.

NPS offers two types of accounts namely, the Tier I and Tier II accounts. The Tier I account is the basic form of an NPS account. Also, it is a mandatory account, while the Tier II account is voluntary. Tier I accounts have a lock-in period until the retirement of the investor. Furthermore, one can choose to extend until the age of 70 years. Only Tier I subscribers can open a Tier II account. Tier-II accounts don’t have any lock-in period or withdrawal restrictions.

NPS investments up to INR 1,50,000 qualify for tax exemption under Section 80C of the Income Tax Act 1961. Furthermore, an additional investment of INR 50,000 also qualifies for exemption under Section 80CCD of the Income Tax Act 1961.

A part of NPS investments goes to equities, and it may not guarantee returns. However, the NPS scheme offers significantly higher returns in comparison to other traditional tax saving schemes. NPS allows investors to change the fund manager if they are not satisfied with the fund’s performance.

Advantages of Investing in an NPS

Following are the advantages of investing in an NPS:

Simple Scheme: Opening an NPS account is very easy. The NPS creates a unique Permanent Retirement Account Number (PRAN) for the subscribers. NPS has two types of accounts:
Tier I account: It is a mandatory account that has a lock in period until retirement. Investors have to make contributions to the account as per the fund chosen.
Tier-II account: It is a voluntary scheme that can be opened only by Tier I subscribers. There is no minimum balance, minimum investment or investment duration restrictions for this account.
Flexible: NPS offers a wide range of pension fund schemes for the investor to plan their investments. Furthermore, NPS subscribers can switch between funds if they are not satisfied with a fund’s performance.
Transferability: Subscriber can easily transfer their account across jobs and locations. Therefore, the subscriber doesn’t have to worry about leaving behind the corpus.
Transparency: The PFRDA regulates NPS with periodic monitoring and performance review of fund managers by NPS Trust. Moreover, it ensures transparent investment norms.
Easy to Access: Subscribers can open and manage their NPS account through the eNPS portal. Furthermore, one can make their contributions online through NSDL CRA or Kfintech CRA.
Low Cost and Power of Compounding: NPS scheme has the lowest account maintenance charges across pension schemes. Furthermore, the investments accumulated until retirement grows with a compounding effect. Therefore, creating a significant surplus for the subscriber by the time of their retirement.
Tax Benefits: Investments in NPS qualify for tax exemption. Investments up to INR 1,50,000 qualify under Section 80C of the Income Tax Act, 1961. An additional INR 50,000 under Section 80CCD of the Income Tax Act, 1961.

What is Systematic Investment Plan (SIP)?

A Systematic Investment Plan (SIP) is an investment route that allows investors to invest a small amount regularly in mutual funds, shares or any other investment. By investing a small amount regularly through SIP, investors can benefit from rupee cost averaging. Moreover, investors also inculcate the practice of financial discipline.

Once an investment is made through SIP, the money automatically gets debited from the investor’s bank account. Hence one need not give a cheque or make a transfer every time the investment is due. The most common form of SIP is the monthly option. However, there are also weekly, quarterly, semi-annual and annual SIP options.

By investing through the SIP route, one need not time the market, nor worry about market dynamics. Since they regularly invest across all market conditions and cycles, they benefit in the long term from rupee cost averaging and the power of compounding.

In SIP, the amount of investment is fixed. The number of shares or units of mutual funds allotted will depend on the amount of investment. In a rising market, a fewer number units are allotted. While in a falling market scenario, a greater number of units are allotted. Since the units are purchased at varying amounts of NAV, the average cost per unit is lower, resulting in more profits in the long run.

SIPs are considered passive investments as no matter how the investment performs, the money gets debited from the investor’s account. Hence it is always important to monitor SIP investments from time to time.

Advantages of Investing in SIP

Following are the advantages of investing in SIP:

Automatic investment: Through SIP, one can invest and forget. The money automatically gets debited from the investor’s account every time the money is due.
Financial discipline: SIP imposes and inculcates the habit of financial discipline through automatic investments.
Small investment: One can start a SIP with an amount as low as INR 500. Hence SIP makes investments accessible to all investors.
Rupee cost averaging: Investing through SIP reduces the average cost of investment over a period of time. This is because the investor invests across market cycles and market conditions.
Power of compounding: SIP coupled with long term investing helps in generating more wealth. Investors can accumulate more wealth with low, regular investments and through compounding effect. Compounding ensures that the returns earned from an investment are also invested to earn more wealth. In other words, it is like getting interest on interest.

Tax Implications of NPS and SIP

SIPs

For SIPs, capital gains are taxed based on how long you’ve held them. Capital gains fall into two categories: long-term and short-term, and the classification depends on the type of Mutual Fund. The dividends you earn from them are not subject to tax.

For an equity fund or an equity-oriented fund, capital gains realised within 1 year are classified as short-term capital gains. If it is after one year, they become long-term capital gains.

On the other hand, for debt funds, debt-oriented hybrid funds, or ELSS funds, gains are considered long-term capital gains if the investment period exceeds 3 years. The table below illustrates the tax implications of these capital gains.

Type of Fund	Short Term Capital Gains	Long-Term Capital Gains
Equity Funds	15%	10% on the capital gains exceeding INR 1 Lakh
Debt Funds	Taxed as per investor’s income tax slab rate	20%

Note: From April 1st 2023, debt mutual funds no longer have long-term capital gains. Irrespective of the investment holding period, the gains are taxable at the individual’s applicable IT slab rate.

NPS

For NPS, 60% of the corpus amount is tax-free. The remaining 40% must be reinvested in an annuity and thus is taxable based on the individual’s applicable tax slab.

Both NPS and SIP for ELSS offer tax benefits under section 80C. NPS investment up to INR 1.5 lakhs qualify for tax exemption under Section 80C of the Income Tax Act. Additionally, you can also enjoy an additional tax exemption of up to Rs. 50,000 on the NPS investment amount under section 80CCD.

NPS vs SIP – Which is Better Investment Plan?

Before considering investing in NPS vs mutual funds through SIP, one has to list down their financial goals and objectives. Then they have to define their investment horizon. And finally, align their goals with the investment’s objectives. Then they should pick the investment that will best suit them.

Mutual funds are better for both short term and long term goals. There are a number of options available to investors that will help them fulfil their immediate goals like buying a car or going on a vacation and long term goals like retirement. Mutual funds offer higher returns than NPS. However, they have a higher risk than NPS too. Also, unlike NPS, mutual funds do not have a lock-in period, except for ELSS funds that have a lock-in period of 3 years. Only investment in ELSS funds qualifies for tax deduction under Section 80C of the Income Tax Act.

NPS suits long term goals like retirement. They offer more stable returns than mutual funds. However, the investment has a lock-in period until the investor turns 60. Investment in NPS also qualifies for tax deduction under Section 80C and Section 80CCD (1B) of the Income Tax Act.

Hence investors have to decide which investment best suits them based on their goals and requirements. They can also take the help of financial advisors to pick the best investment that suits them.

Frequently Asked Questions

How should one decide between NPS and SIP investments?

The choice between NPS and SIP investment largely depends on the investor’s investment goal. If you want to build a retirement corpus with moderate risk, NPS is a better option. On the other hand, if your risk tolerance level is high and you have a long-term investment horizon, mutual funds SIPs can be your option.

What is the difference in the lock-in period of SIP and NPS schemes?

The lock in period for NPS is until retirement. On the other hand, only ELSS mutual funds have a lock-in period of three years.

SIP Vs NPS – Which scheme gives higher returns?

SIPs have the potential to generate higher growth than NPS. Since SIPs are suitable for the long term, they tend to average out the market volatility and generate higher growth. Furthermore, the benefit of the power of compounding also adds to higher growth.

Do I need a large amount of money to invest in a SIP scheme?

No. You can start your mutual fund SIP investments with as little as INR 500.