NPS vs mutual funds: how they differ for retirement saving

NPS and mutual funds both put your money into shares and bonds, but they are different things. NPS is a pension account with rules on when the money comes out and how much of it must buy a pension. An equity mutual fund other than ELSS can be sold on any business day. Neither fits every goal, and the differences below decide which one does.

Is NPS a mutual fund?

No. NPS, the National Pension System, is a pension account regulated by the Pension Fund Regulatory and Development Authority (PFRDA). A mutual fund is a pool of money from many people, invested by a professional manager under rules set by SEBI, the Securities and Exchange Board of India.

Both invest in equity (shares of companies) and debt (loans to governments, banks or companies, in the form of bonds).

In NPS, the money is held by the NPS Trust and invested by pension funds registered with PFRDA. Record-keeping agencies keep your account. Banks, India Post and other "points of presence" open accounts and take contributions. A SIP is not a rival to NPS. A SIP, or systematic investment plan, is a way of putting a fixed amount into a mutual fund at regular intervals, usually monthly. So "NPS or SIP" is this same comparison, with the fund the SIP buys on one side.

How do NPS and mutual funds compare?

They differ most in when you can take money out and what you must do with it at the end.

NPS also has a Tier II account, which behaves most like a mutual fund. It is optional and needs an active Tier I account. You can withdraw at any time. In PFRDA's words, "It's an investment account and not eligible for tax benefits". The NPS account guide covers both tiers.

What are the NPS scheme choices?

Since 28 August 2026, NPS offers three kinds of scheme. Life cycle funds are four age-based schemes. Active Choice lets you split the money across shares, corporate bonds and government securities, with up to 75% in shares in Tier I and up to 100% in Tier II. Pension funds also run their own schemes, graded A to E: grade A holds 80% to 100% in shares, and grade E holds 0 to 10%.

So NPS is not one risk level; it depends on the scheme.

When can you take your money out?

From NPS, money comes out at a normal exit, at a premature exit, or in part after three years for a listed purpose. From an equity fund other than ELSS, you can sell on any business day, and the proceeds must reach you within 3 working days (5 for funds with at least 80% in overseas investments).

NPS exits

For a non-government subscriber, normal exit is at 15 years of subscription or at age 60, whichever is earlier. At least 20% of the balance must buy an annuity, a product that pays a regular pension. Up to 80% can come out as a lump sum (one payment) or in regular instalments. A balance of ₹8 lakh or less can be taken in full. Above ₹8 lakh and up to ₹12 lakh, up to ₹6 lakh can come out and the rest goes to an annuity or to regular redemption of units over at least six years. You can also defer the exit until 85.

A premature exit is one before that normal point. At least 80% of the balance then buys an annuity, unless the balance is ₹5 lakh or less, when all of it can come out. Government subscribers must use at least 40% for an annuity at retirement.

After three years you can withdraw up to 25% of your own contributions, not counting returns. The purposes are a child's higher education or marriage, a first house (once), medical treatment for you or your family, a disability, or repaying a loan against the NPS account. Before 60 you can do this four times, at least four years apart. The new NPS rules post has more.

Mutual fund exits

Some funds charge an exit load, a fee if you sell within a set time after buying. ELSS, the tax-saving equity fund, has a three-year lock-in, a period when you cannot sell at all. It must hold at least 80% in equity and equity-related instruments. In a SIP, each instalment is locked in for three years from its own allotment.

How are NPS and mutual funds taxed?

The tax differs at both ends. On the way in, NPS can give a deduction in the old tax regime; on the way out, a fixed share of NPS cash is tax-free. A mutual fund gives no deduction except ELSS, and its gains are taxed when you sell.

Tax on the way in

The old tax regime is the one where the deductions below still apply. There, your own NPS contribution counts under section 123 (the old Section 80C). The limit is 10% of salary for an employee, or 20% of gross total income for others, inside the ₹1,50,000 total for section 123. Section 124(3), which replaced 80CCD(1B), allows up to ₹50,000 more, over and above that.

ELSS also counts under section 123, within the same ₹1,50,000 across all items, and again only in the old regime. The comparison of PPF, ELSS and NPS sets the three side by side.

In the new tax regime, which is the default, neither your own NPS contribution nor ELSS cuts your tax. Only an employer's contribution to your NPS does, up to 14% of salary under section 124(1), whatever the employer. Under the old regime the limit is 14% for a government employer and 10% for others. For a reader in the new regime, tax on the way in is the same for own NPS money and for mutual funds: nothing.

Tax on the way out

At an NPS exit, up to 60% of what you are paid is tax-free. The rules now let you take more than 60% as cash. The part above 60% is added to your income for that year. It is taxed at your slab rate, the rate for the band your income falls in. The money used to buy an annuity is not taxed when you buy it, but the pension is taxed as income when you receive it. A partial withdrawal is tax-free for an employee.

For mutual funds, the tax is on capital gains, the profit when you sell units. An equity-oriented fund is one that invests at least 65% in equity shares of Indian listed companies. For such a fund:

• Units held for 12 months or less give a short-term gain, taxed at 20%.
• Units held for more than 12 months give a long-term gain, taxed at 12.5% on gains above ₹1,25,000 in the tax year.
• A 4% cess is added to the tax in both cases.

A Specified Mutual Fund is one that invests more than 65% in debt and money market instruments. Its units bought on or after 1 April 2023 are always short-term and taxed at your slab rate, whatever the holding period. The mutual fund redemption tax post explains which funds count.

The same rupee figure on both sides

Take Kunal, 35, a salaried employee on the new tax regime, thinking about retirement saving. These are illustrations of the rules, not of returns.

Suppose his NPS balance is ₹20,00,000 at a normal exit as a non-government subscriber. At least ₹4,00,000 must buy an annuity, and up to ₹16,00,000 can come out as cash. Of the balance, ₹12,00,000 (60%) is tax-free. If he takes all ₹16,00,000 as cash, the other ₹4,00,000 is taxed at his slab rate, and the annuity's pension is taxed each year.

Now suppose he sells equity-oriented fund units held for more than 12 months, with ₹8,00,000 of gains in one tax year and no other equity gains that year. Tax is 12.5% on ₹6,75,000, the gain above ₹1,25,000. That is ₹84,375, plus 4% cess, so ₹87,750. This assumes total income under ₹50 lakh, so no surcharge. Nothing has to buy an annuity.

What do you get at the end?

NPS turns at least a fifth of the balance into a pension (two fifths for government subscribers), while mutual fund units stay yours to sell when you choose.

The NPS annuity is bought from one of 17 life insurers approved by PFRDA. The NPS annuity guide shows how that works. The cash part need not come out in one go. You can draw a fixed amount at regular intervals, or sell a fixed number of units each time, while the rest stays invested.

For a regular income from a mutual fund, you can use an SWP, a systematic withdrawal plan that sells a set amount of units at regular intervals. The SWP guide, the SWP calculator and the post on mutual funds in retirement planning go further.

Can you use NPS and mutual funds together?

Yes. Each keeps its own rules. The factors that decide how much goes to each are personal:

• How long until you need the money.
• Whether you might need some of it early.
• Your tax regime, old or new.
• Whether your employer contributes to your NPS.
• How big a fall you can sit through.

Neither takes away market risk, and an equity-heavy scheme of either kind can fall in a bad year.

Koshex is an app run by an AMFI-registered mutual fund distributor. If you decide on a mutual fund, it helps you choose a fund that suits your goal and timeline. Koshex holds ARN-154632, sells regular plans (the version of a fund you buy through a distributor) and runs SWPs. You can browse mutual funds, including equity funds and ELSS funds, or try the SIP calculator and the NPS calculator.