Understanding NPS and mutual funds for tax-efficient investing

 

• Table of contents

1. Understanding NPS
2. Understanding mutual funds
3. Tax benefits of NPS and mutual fund
4. Tax benefits of mutual funds
5. Additional tips

Understanding NPS

The National Pension System (NPS) is a voluntary, long-term retirement savings scheme designed to provide financial stability during the post-retirement phase. It is regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

Contributors to the NPS, including both employees and self-employed individuals, can build a retirement corpus by regularly contributing to their NPS accounts. The accumulated corpus is invested over time and is made available as a pension upon retirement.

Understanding mutual funds

Mutual funds, on the other hand, are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. Managed by professional fund managers, mutual funds offer a wide range of investment options catering to various risk appetites and financial goals.

Investors in mutual funds purchase units, and their returns are proportional to the performance of the underlying securities in the fund's portfolio. Mutual funds provide growth potential, flexibility, liquidity, and diversification, making them a popular choice among investors with different risk profiles.

Tax benefits of NPS and mutual fund

NPS tax saving

Tax Deduction under Section 80CCD(1)

Employees participating in the National Pension Scheme (NPS) can avail themselves of tax benefits on their contributions as follows:

A tax deduction of up to 10% of their salary (Basic + DA) under Section 80CCD(1), capped at a maximum of Rs. 1.5 lakh under Section 80CCE.

An additional tax deduction of up to Rs. 50,000 under Section 80CCD(1B), in addition to the overall limit of Rs. 1.5 lakh under Section 80CCE.

Additional deduction for self-employed

Individuals who are self-employed and contribute to the National Pension Scheme (NPS) are eligible for the following tax benefits on their personal contributions:

A tax deduction of up to 20% of their gross income under Section 80CCD(1), with a maximum limit of Rs. 1.5 lakh under Section 80CCE.

An additional tax deduction of up to Rs. 50,000 under Section 80CCD(1B), in conjunction with the overall limit of Rs. 1.5 lakh under Section 80CCE.

The employer's contribution to the NPS, up to 10% of the salary (basic plus DA), is deductible from the employee's income under Section 80CCD(2).

Tax-free withdrawals

While the maturity amount is not entirely tax-free, NPS offers partial tax-free withdrawals. An individual can withdraw up to 60% of the corpus tax-free at the time of retirement.

Tax benefits of mutual funds

Equity-linked savings scheme (ELSS)

ELSS, a category of equity mutual funds, offers tax benefits under Section 80C of the Income Tax Act, 1961. Investments in ELSS funds qualify for a deduction of up to Rs. 1.5 lakh in a financial year.

Tax efficiency of equity funds

Long-term capital gains (holding period of more than one year) from equity mutual funds are taxed at a lower rate of 10% without indexation benefit, making them tax-efficient for investors. LTCG up to Rs. 1 lakh annually are exempted from taxation.

Additional tips

Align investments with financial goals

Tailor your investments in NPS and mutual funds to your financial goals. Whether it's retirement planning with NPS or wealth creation with mutual funds, align your investments with your specific objectives.

Regularly review and rebalance

Periodically review your NPS and mutual fund portfolios to ensure they align with your financial goals and risk tolerance. Rebalance your portfolio as needed, considering changes in market conditions and personal circumstances. Using a retirement pension plan calculator can simplify this process by providing clear estimates of your future retirement needs based on your current savings and expected returns.

Conclusion

Understanding NPS and mutual funds for tax-efficient investing involves recognising each instrument's unique benefits. NPS provides specific deductions and partial tax-free withdrawals at retirement, making it an invaluable tool for retirement planning. On the other hand, mutual funds, especially equity-linked options, offer tax efficiency and flexibility.

FAQs:

What is NPS?

The National Pension Scheme is a voluntary long-term retirement savings scheme designed to provide financial stability during the post-retirement phase.

Is it better to invest in NPS or mutual funds?

Choosing between NPS and mutual funds depends on your financial goals and risk appetite.

Is it better to pay tax or invest in NPS or mutual fund?

Investing in NPS or mutual funds can offer tax benefits. However, the choice depends on one’s specific financial objectives and risk tolerance.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.