Saving money with a disciplined approach is crucial to building a corpus for retirement. Individuals use numerous retirement planning schemes to save their funds for retirement. A Systematic Investment Plan (SIP) and National Pension Scheme (NPS) are very common investment options that most individuals use to save funds for retirement.
This blog guides you in choosing the better investment option between NPS and SIP by creating a difference between NPS vs SIP and highlighting their tax implications.
Understanding the National Pension System
The NPS is a government initiative to offer social security to the employees of the public, private, and unorganised sectors. You have to allocate a particular amount regularly from your income in the pension account during your employment period.
You are eligible to withdraw a percentage of the total corpus at the time of maturity. The remaining amount will be credited to your bank account each month as a pension. The government initiated the NPS in 2004. However, in 2009, it was extended to private-sector employees in India.
Understanding Systematic Investment Plan
The systematic withdrawal plan or SIP is a common investment option among millennials. You will be able to invest a fixed amount regularly using an SIP. In each month, a fixed amount will be debited from your account and used to buy mutual fund units that you have chosen.
A SIP helps you put your money in a particular mutual fund scheme and earn consistent returns. Using the power of compounding, you can increase your capital exponentially. Investing in mutual funds with an SIP can help you to get dividend payments on your investments.
Benefits and Drawbacks of NPS
Here are some of the benefits you can get while investing in NPS:
- Voluntary Contribution: You have the flexibility to choose a specific time for contributing to the NPS programme.
- Flexibility: You may choose from a variety of investment options that help to build your pension fund.
- Transparency: Investing in the NPS programme is transparent as it is controlled by the Pension Fund Regulatory and Development Authority (PFRDA).
These are the drawbacks of NPS from which you must be aware of:
- Limited Scope of Withdrawal: There are restrictions on the withdrawal of NPS before the maturity stage.
- Complications for New Investors: New investors might find it challenging to grasp the asset allocation and fund management concepts of NPS.
- Lesser Equity Exposure: NPS slowly reduces the percentage of equities with ageing. NPS reduces by 2.5% equity investment every single year once you have reached 50 years.
Benefits and Drawbacks of SIP
You may avail these benefits while investing in a SIP:
- Compounding Benefits: Investing in SIP enables you to enjoy the power of compounding. This helps you to build wealth faster with long-term investments than one-time investments.
- Rupee-Cost Averaging: Investing in SIP helps you to use the rupee-cost averaging. This allows you to cut down the mutual fund’s cost per unit.
- High Returns: Mutual funds generate inflation-beating returns when compared with traditional investment options.
These are the drawbacks of investing in SIPs:
- Vulnerable in a bullish market: SIPs do not work when the market rises because you buy fewer units with the same amount while prices go high.
- Lock-in Period: Your money will be locked for three years if you invest in a tax-saver mutual funds scheme, like ELSS.
What are the Key Differences Between NPS and SIP?
It is difficult to choose a better investment option between NPS and SIP, without analysing the difference. The following table showcases the differences of NPS vs SIP based on some aspects:
| Aspects | NPS | SIP |
| Purpose | The main purpose of investing in NPS is to build a fund for your post-retirement life. | You may have different purposes for investing in mutual fund SIPs. You can start an SIP to ensure long-term wealth creation for numerous reasons including creating a retirement corpus, children’s education, and even medical emergencies. |
| Risks | NPS includes low to high levels of risks based on the asset allocation. | Risks in mutual fund SIPs depend on the market and the fund chosen. |
| Lock-in Period | You cannot withdraw from your Tier 1 NPS account before retirement, without some exceptions. Meanwhile, you can withdraw funds anytime by opening a Tier 2 NPS account. | Except for close-ended mutual funds and Equity Linked Savings Schemes (ELSS) funds, there is no lock-in period in SIPs. The ELSS funds have a lock-in period of 3 years. |
| Assets | NPS invests your funds in assets like government bonds, equities, corporate bonds, and other funds. | Through SIPs, mutual funds invest your money in equities, debt, or a combination of these two. |
| Returns | The returns of your NPS will be determined by the performance of the assets. | Your returns on SIPs will be determined by the performance of the mutual fund in which you have invested. |
Tax Implications on SIP and NPS
While choosing any one between SIP and NPS, you need to know about their tax implications which have been described below:
- NPS Tax Deductions: Under Section 80C of the Income Tax Act, you are eligible to claim a tax deduction of a maximum ₹1.5 lakh for making contributions to your NPS. In addition, you are allowed to claim another tax deduction of a maximum ₹50,000 under the sub-Section 80CCD (1B).
- ELSS Tax Deduction: You may claim up to ₹1.5 lakh for investing in ELSS in a financial year under Section 80 of the IT Act.
- SIP Dividends: You can also save tax while earning dividends from SIP investments.
- LTCG and STCG: You have to pay a 20% STCG tax on the redemption of mutual funds before the completion of one year of investment. Meanwhile, you have to pay a 12.5% LTCG tax if your investment amount crosses ₹1.25 lakh and you want to redeem the funds after one year of investment.
SIP vs NPS: How to Choose Between These Two?
After analysing the difference between SIP and NPS, it depends on your risk tolerance, investment objectives, and horizon. For instance, if you are comfortable with the lock-in period and do not want to take risks, you can consider investing in NPS.
On the other hand, if you can take risks, you can invest in SIPs. This will help you to make long-term wealth creation. It is also important for you to consider the tax obligations before choosing any one option from SIP and NPS.
Final Thought
Analysing the differences between NPS vs SIP, you can choose any one of the options based on your investment goal and risk tolerance. Both the NPS and SIP include numerous benefits as well as drawbacks. However, it is always recommended to have proper knowledge before you start investing in NPS or a mutual fund SIP.
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