NPS Tier 2 Vs Mutual Funds – Which is better to invest? Can we use NPS Tier 2 as it offers tax-free rebalancing or due to its low-cost nature than mutual funds?
The majority of us look for tax-free or low-tax investment options and when we weigh Mutual Funds with other products, we end up comparing NPS Tier 2 Vs Mutual Funds. However, we forget important aspects of why we are investing and what are the drawbacks of alternative products. Hence, in this post, I will dwell on the pros and cons of using NPS Tier 2 as an alternative to Mutual Funds.
NPS Tier 2 Vs Mutual Funds – Which is better to invest?
As many of us are aware NPS Tier 2 does not have any lock-in feature like NPS Tier 1. Also, the financial world preaches to us that NPS is one of the cheapest pension products (however the reality is entirely different. Read my earlier post in this regard “Charges of investing in NPS – It is not so cheap!!“).
I have written a detailed post on the NPS Tier 1 Vs NPS Tier 2 (Difference between Tier 1 and Tier 2 Account in NPS). Hence, I will delve into explaining the features of NPS Tier 1 and NPS Tier 2.
Few points one must understand before choosing NPS Tier 2 as an alternative to Mutual Funds are listed below for better decision-making.
# You can’t open an NPS Tier 2 Account directly without having an NPS Tier 1 Account. This makes you to contribute certain minimal amount on yearly basis to the NPS Tier 1 Account to make it active (assuming your main idea of investing is only NPS Tier 2 but not Tier 1).
# There is no clarity on the equity portfolio mandate or benchmark they have to follow. Even though they follow BSE 200 or NSE 200 as a benchmark, there is no clarity on the mandate and also what I found was that few pension funds invest in certain mutual funds of their own sister concern or in other mutual funds. I can’t understand this logic fully!! Hence, you don’t have clarity or control over your portfolio when you explore NPS Tier 2.
# Coming to debt portfolio, I have pointed this out many times. They have the same debt portfolio for all investors. Whether you are a 30-year-old investor or a 58-year-old who is about to retire. Many assume equity means risk and debt means safety. However, it poses a huge risk if you don’t know how the bond market works. Just moving to debt portfolio of NPS does not mean your money will be safe. Even if we assume pension fund managers are GOD in managing the default or credit risk, one can’t manage perfectly the interest rate risk (especially if you are holding long-term bonds).
# In simple, you don’t have risk management control or clarity on what the NPS Fund Managers do with your money (especially in the absence of a clear mandate).
# If you compare the cost, as I shared above, it is not so cheap to feel proud of. Hence, investing just because its liquid and low-cost is not the right investment decision.
# Yes, it offers tax-efficient rebalancing which may not be possible if you are holding in mutual funds or for that matter in any other products. But with this one pro, you end up facing more cons.
# If you explore the taxation, which many are unaware of, the gains from NPS Tier 2 are taxable as per your tax slab!! Refer to my earlier post on this “NPS Tier 2 Tax Benefits 2023 – Under New Tax and Old Tax Regimes“. When there is no tax benefits at the time of investing (excluding central government employees) and taxed heavily at the time of withdrawal, is it wise to explore NPS Tier 2?
# Yes, one alternative to avoid the tax from NPS Tier 2 is after your accumulation when you are about to withdraw for your retirement (as per the exit rules of NPS Tier 1), you can move the money from NPS Tier 2 to NPS Tier 1 and then opt for the withdrawal. This movement will allow you to save certain taxes as you are allowed to withdraw around 60% of your accumulated corpus without any tax hurdle. However, this comes with lock-in up to the retirement age and also the remaining 40% is taxable. Hence, the purpose of liquidity is not fulfilled if you opt for this strategy.
# Because of this heavy taxation, even though you may postpone the taxation with tax-free rebalancing, you end up in paying hefty taxes at maturity or lock-in the money (when you move to NPS Tier 2).
Conclusion – Considering all these reasons like – no clarity on the portfolio and performance of equity and debt portfolio, a wrong notion about low cost, hefty tax at the time of withdrawal, and most importantly no control over your portfolio makes the choice of NPS Tier 2 as an alternative to Mutual Funds is the wrong choice. Just because it offers tax-free rebalancing does not mean NPS Tier 2 is a great product. The most important thing to consider is that the control should be in your hands with clarity about where each rupee will get invested.
Beware – With recent clarity from SEBI, few RIAs (whom you think they can’t sell and can’t earn the commission) may now sell you insurance products or force you to invest in NPS and can earn the commission (however, they have to disclosure this commission earning in the engagement). Such recommendations in my view again bring in the conflict of advice. Hence, be cautious from now onwards with such RIAs.
Refer my few posts on NPS –
- NPS Vatsalya Scheme – Don’t Invest BLINDLY!!
- Opted New Tax Regime – Should I stop investing in PPF, SSY, and NPS?
- The Hidden Risks of NPS Debt Portfolio – Are you aware?
- All about NPS Systematic Lump Sum Withdrawal (SLW)
- SIP in NPS – How to set using D-Remit deposit facility?
- National Pension Scheme (NPS) – 5 Biggest Disadvantages
- NPS Tier 2 – Alternative to Savings Account, FDs or Debt Mutual Funds?
