SIP Vs NPS: Which Investment Plan Is Better?

Introduction

When it comes to choosing an investment for long-term goals, especially retirement, you have likely come across two popular abbreviations – SIP and NPS. While SIP stands for Systematic Investment Plan, which is a mode of investing in mutual funds, the full form of NPS is National Pension System, a government-backed long-term savings scheme that allows individuals to accumulate their retirement corpus. This article explores the details of SIPs and NPS to help you decode the NPS vs SIP dilemma and choose the right tool for your goals. 

What Is NPS – NPS Meaning Explained

Managed by the Pension Fund Regulatory and Development Authority (PFRDA), NPS is designed to promote long-term savings for retirement. It allows you to make regular contributions during your working years in order to secure the second innings of your life. 

Fund managers invest NPS contributions in a mix of asset classes, such as stocks, government bonds, or corporate debt. As a result, NPS returns are market-linked and not fixed like many traditional retirement schemes.

NPS encourages long-term investing by restricting withdrawals until retirement, i.e., the age of 60. Upon retirement, you can withdraw 60% of the account balance as a lump sum, while the remaining 40% must be used to purchase an annuity, which will provide you with a monthly pension. Premature withdrawals are allowed only under special circumstances and are subject to conditions. 

While many investments offer tax savings under Section 80C, NPS is popular for additional tax deductions beyond the 80C limit.  

What Is SIP – Meaning Of SIP Explained

An SIP is a mode of investing in mutual fund schemes, which also offer market-linked returns. It allows you to invest a fixed amount of money in your chosen mutual fund at predetermined intervals – daily, weekly, monthly, quarterly, half-yearly, or even annually. 

One of the biggest SIP benefits is rupee cost averaging. Since you invest during different market cycles, you get more units when prices are low and fewer units when they are high. This helps average out your total investment cost over time and also allows you to build a large corpus through the power of compounding. 

You can start an SIP with an amount as low as ₹100 per month, which makes it easy for most investors to begin investing. Apart from being light on the pocket, SIPs also help inculcate financial discipline. This justifies the full form of SIP – “Systematic” Investment Plan.  

There are different mutual funds to suit different investor profiles. You can assess your financial goals, risk appetite, budget, and investment horizon before choosing a fund to start an SIP.

NPS vs SIP: Key Differences Explained

Here’s a quick glance at the key features of NPS and SIP: 

Tax Implications

• Taxation Of SIPs

The taxation of your SIPs depends on the mutual fund scheme in which you invest. 

Equity-oriented funds: The tax rate depends on the holding period, i.e., the duration for which you stay invested. If you redeem your equity investment within 12 months, gains are classified as Short-Term Capital Gains (STCG) and taxed at 20%. If you redeem after 12 months, gains are classified as Long-Term Capital Gains (LTCG) and taxed at 12.5%. However, LTCG up to ₹1.25 lakh per financial year are tax-exempt. 

Note: Each SIP instalment is considered a separate investment, and the holding period is calculated accordingly. 

Debt-oriented funds: Post-Budget 2023, the holding period no longer affects taxation. Gains are taxed as per your income tax slab, irrespective of how long you stay invested.  

Apart from equity and debt, there are other types of mutual funds as well, and their tax treatment may differ.

• Taxation Of NPS 

NPS offers attractive tax benefits. Employee contributions up to 10% of basic salary plus dearness allowance qualify for a deduction under Section 80CCD(1), subject to the overall ceiling of ₹1.5 lakh under Section 80CCE. An additional deduction of up to ₹50,000 per year is allowed under Section 80CCD(1B). This is over and above the ₹1.5 lakh limit.

Employer contributions to NPS also qualify for a tax deduction* under Section 80CCD(2). This deduction is over and above the ₹1.5 lakh limit under Section 80CCE.

NPS maturity proceeds are tax-free. However, the pension income received from the 40% balance used to purchase an annuity is taxable according to your income tax slab.

^{* Up to 10%/14% of basic salary plus dearness allowance for private sector employees/government employees, respectively.} 

Why Should You Choose SIP or NPS?

There is no clear winner between SIP and NPS. The choice ultimately depends on your individual profile. 

You can choose NPS if you want to save for your retirement while simultaneously optimising your tax savings. It is ideal if you do not prioritise liquidity and are comfortable with long-term investing. 

If you have multiple goals apart from retirement, you can explore SIPs in different mutual funds. SIPs offer higher return potential and greater flexibility. Multiple SIPs can also help you achieve diversification and minimise losses. 

Conclusion

Both SIPs and NPS are effective tools for securing your financial future. While SIPs facilitate systematic wealth creation, NPS focuses on retirement security and offers attractive tax benefits. Your choice must align with your goals, liquidity needs, and investment horizon. 

Additional Read: SIP Vs Mutual Funds: Difference Between SIP & Mutual Funds