Retirement Planning NPS Vs MFs

Most of us tend to ignore the glaring fact that our financial needs will be as much or maybe even greater after retirement from an active professional phase. Not only will the sources of monthly income dry up, certain factors like rising healthcare costs and inflation cannot be ignored. Therefore, financial planning to be able to continue living a secured and comfortable life is highly crucial. This article will equip you with the knowledge to navigate this significant aspect of your financial journey [EasyDNNnews:PaidContentStart]

Imagine yourself, years from now, living a life of leisure and comfort. You travel the world, pursue hobbies long neglected, and spend quality time with loved ones. This idyllic picture of retirement isn’t a pipe dream but an achievable reality with thoughtful planning. However, let’s face it: In today’s fast-paced world, retirement planning often takes a backseat. Yet, the importance of securing your financial future cannot be overstated. In India, unlike some Western countries, there’s no single, comprehensive social security system to guarantee income after retirement. The onus falls on individuals to create their own retirement corpus. 

Need to Plan for Retirement
Here’s a reality check: Our earning capacity diminishes as we age. Relying solely on your children or traditional pension plans might not be enough to maintain your desired lifestyle after retirement. Medical expenses tend to rise with age, and inflation can significantly erode the purchasing power of your savings. Early and effective retirement planning helps bridge this gap, ensuring financial independence and peace of mind in your golden years. 

The Power of Two: Mutual Funds and NPS
Now, let’s delve into the two prominent instruments that can be leveraged for retirement planning in India – mutual fund (MF) schemes and the National Pension System (NPS). There are also other instruments such as Public Provident Fund (PPF) and gratuity payment that can be utilised for retirement planning. However, we will analyse only MF and NPS in this article. 

Mutual Fund Schemes for Retirement
There are two ways in which you can use mutual funds. The first option is that you can use the readymade retirement solutions provided by mutual funds. Or, you can plan your investments through a mutual fund to build a retirement corpus and use different techniques to withdraw from this corpus to finance your retirement. In solution-oriented schemes targeting retirement, there are little less than 30 existing schemes across 12 fund houses overseeing a corpus of more than ₹25,000 crore as of March 2024. These schemes broadly fall into equity, debt and hybrid baskets. 

Retirement funds have traditionally been oriented towards hybrid schemes, with offerings such as the UTI Retirement Fund and Franklin India Pension Plan. However, over the past decade, various fund houses, including Tata, Nippon India, HDFC, ICICI Prudential, Aditya Birla, Axis and SBI, have introduced multiple variants of retirement schemes tailored to different investment approaches. For instance, Tata introduced three variants – progressive (equity-oriented), moderate (aggressive hybrid-oriented) and conservative (debt-oriented). Some fund houses provide automatic switching options between these schemes based on the investor’s age. 

For example, Nippon India Mutual Fund offers an auto transfer facility from their wealth creation plan (equity-oriented) to income generation plan (debt-oriented) upon the investor reaching 50 years of age. From the table alongside it is clear that pure equity funds are comparable to Hybrid Funds. Nevertheless, it is fair to assume 10-12 per cent of annualised returns from such category of funds. Retirement funds typically entail a lock-in period, prohibiting early redemption until the investor either reaches retirement age or completes five years, whichever comes first. 

Top 8 Solution Oriented (Retirement) Fund Based On 5 Years Returns 

Tata Mutual Fund schemes, however, allow early withdrawals with an exit load of 1 per cent, while Franklin imposes a 3 per cent exit load for investors under the age of 58. A retirement fund is just one of the means of saving for your golden years. Traditionally, individuals can allocate their savings into a mix of diversified equity, debt and hybrid funds, aimed at generating steady returns over time and building a handsome retirement corpus. However, the idea of a dedicated retirement-focused fund doesn’t necessarily offer any distinctive advantages. In fact, it often imposes restrictions on liquidity, enforcing a five-year lock-in period that inhibits the flexibility to exit underperforming funds. Moreover, unlike some other investment vehicles, there is no inherent tax benefit associated with such funds. 

Building a Retirement Nest with Mutual Fund
As discussed in the above paragraph, you can also use different categories and sub-categories of mutual fund schemes to build a retirement fund. To do so, your first step is to envision your ideal retirement lifestyle. Consider factors like desired location, travel plans, healthcare needs, and any dependents you might have. Translate these dreams into a realistic estimate of your monthly retirement expenses. Next, assess your current financial situation. Estimate your potential retirement income sources, including Public Provident Fund (PPF), company pensions (if applicable), gratuity and any expected inheritance. 

Now, subtract this from your estimated monthly retirement expenses multiplied by your longevity and applying the appropriate inflation rate. This gap represents the amount you will need to bridge through your own savings and investments. The earlier you start investing, the more time your money has to grow through the power of compounding. Compounding allows your returns to generate even more returns over time, thereby significantly boosting your retirement corpus. Investing involves risk. Equity-based MFs offer the potential for higher returns but also carry higher volatility 

Debt Funds offer lower risk and returns. Evaluate your comfort level with risk to determine the appropriate asset allocation for your portfolio. Generally, younger investors with a longer time horizon can tolerate more risk for potentially higher returns. You can use a systematic investment plan (SIP), which is a powerful tool for building your retirement corpus. SIP allows you to invest a fixed amount regularly (monthly, quarterly, etc.), inculcating discipline and leveraging rupee-cost averaging. By investing at different market points, you average out the cost per unit, potentially mitigating the impact of market volatility. 

As market conditions change, your asset allocation might get skewed. Periodically, rebalance your portfolio back to your target allocation to maintain the desired risk profile. Remember, building a retirement corpus with MFs is a marathon, not a sprint. By starting early, investing regularly, and making informed decisions, you can build a secure financial future and enjoy a comfortable phase of retirement. The following table gives you the expected return from different asset classes over a longer period and this is the return you can expect from your investment for retirement. This weight will change based on your age and risk tolerance and accordingly influence the expected returns. 

National Pension System (NPS)
Launched by the Government of India, the National Pension System is a voluntary, defined contribution pension scheme. It is a very structured retirement savings scheme. The Pension Fund Regulatory and Development Authority (PFRDA) has appointed a set of professional fund managers from reputed asset management companies (AMCs) to manage NPS funds. So, typically, you are saving until you retire. At the age of 60, you get a lump sum and after that you start getting an annual payout every year as an annuity. So, it is very structured. Here’s how it works: You contribute a portion of your salary (or any other regular savings) to your NPS account. 

The corpus is then invested by professional fund managers in a mix of equity, corporate debt and government bonds, depending on your chosen asset allocation. Upon reaching retirement age (currently 60 years), you take out 60 per cent of your corpus for which you do not have to pay tax. The remaining 40 per cent can be parked into an annuity so that it prevents you from spending all your money. This is as per the rule laid down by the NPS. An annuity means it will pay you every year from then onwards once you are retired. Therefore, you, by design, will get that money over many years as an annuity payout. However, the money you get as annuity will be taxed as per your prevailing tax bracket. 

The Investment Route
NPS offers a pre-defined asset allocation strategy based on your age. This reduces the burden of actively managing your investments and helps maintain discipline throughout your contribution period. There are three asset classes within NPS:
1. Equity (E): Invested in stocks of Indian companies. This option offers potential for higher returns but also carries higher risk.
2. Corporate Debt (C): Invested in bonds issued by Indian companies. This option offers lower risk and returns compared to equity.
3. Government Bonds (G): Invested in bonds issued by the Indian government. This option offers the lowest risk and returns among the three. 

NPS Asset Allocation Tiers
The percentage allocation to each asset class automatically changes as you age, becoming more conservative closer to retirement. Here’s a simplified breakdown (actual percentages may vary):
1. Age Below 30: Equity (E) – 50 per cent, Corporate Debt (C) – 30 per cent, Government Bonds (G) – 20 per cent (Aggressive Growth).
2. Age 30 – 50: Equity (E) – 40 per cent, Corporate Debt (C) – 40 per cent, Government Bonds (G) – 20 per cent (Balanced Growth).
3. Age 50 and Above: Equity (E) – 30 per cent, Corporate Debt (C) – 40 per cent, Government Bonds (G) – 30 per cent (Income and Stability). 

The following table shows the average returns of different fund managers across different periods. It clearly shows that equity returns are similar to MF equity returns but fixed income instruments have given better returns compared to MFs. One of the reasons for better return by NPS fund managers is the lower expense ratio. They can charge a maximum of 0.09 per cent compared to 2 per cent by many of the other MF schemes. This makes a lot of difference when it comes to returns. 

NPS offers attractive tax benefits. Contributions made towards NPS qualify for deduction under Section 80 C of the Income Tax Act, with an additional deduction of up to ₹50,000 under Section 80 CCD (1). There is a separate tax benefit under Section 80 CCD (2), which is a contribution by the employer to the NPS and can also be claimed in the tax filing. This can significantly reduce your tax liability and boost your retirement savings. Nonetheless, NPS comes with a long lock-in period, with withdrawals generally allowed only upon reaching retirement age, allowing only for specific exceptions. This enforces long-term discipline and ensures your retirement corpus remains untouched until you truly need it. 

Choosing the Better Option
When deciding between MFs and the NPS for retirement planning, the answer, like most financial decisions, is ‘it depends’. Both MFs and NPS have their own pros and cons, and the ideal choice will be based on your individual circumstances, risk appetite and retirement goals. Mutual funds are a suitable choice if you have a higher risk tolerance and are looking for potentially higher returns. They offer greater flexibility in terms of investment and withdrawal options, allowing you to adjust your strategy as needed. If you are comfortable managing your own investment portfolio and making informed decisions about asset allocation, MFs can be a rewarding option. 

The ability to diversify across various asset classes and sectors also adds to their appeal, particularly for those who prefer a hands-on approach to their investments. On the other hand, the National Pension System is ideal for those who prefer a more structured and disciplined approach with a long lock-in period. NPS is particularly attractive if tax benefits are a major priority, as it offers significant tax advantages under various sections of the Income Tax Act. 

Additionally, the stability and security provided by a government-backed scheme can be reassuring for many investors. NPS mandates the purchase of a fixed annuity upon retirement, ensuring a regular income stream, which can be beneficial for those who seek financial security in their post-retirement years. Ultimately, the choice between MFs and NPS should align with your retirement objectives, risk profile and financial preferences. By carefully evaluating these factors, you can make an informed decision that supports your long-term financial wellbeing. 

Conclusion
Retirement planning is not a one-size-fits-all approach. Both mutual funds and NPS offer distinct advantages and can play a crucial role in building a robust retirement portfolio. For a balanced approach, consider a combination of both the instruments. Mutual funds can provide growth and flexibility, while NPS can offer stability and guaranteed income. You can use both these instruments and its advantages to build a retirement corpus.

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