The National Pension System (NPS) funds have quietly outperformed mutual fund schemes in terms of returns, even as investors are bombarded by the extensive promotion of mutual funds through the ‘mutual funds sahi hai’ campaign. Over the past decade, NPS equity funds have consistently surpassed the largecap mutual fund category, with the flexi-cap category only slightly ahead.
NPS debt funds have also demonstrated superior performance compared to mutual fund debt schemes. In the previous year, the NPS Tier II Gilt and Corporate Bond funds have generated higher returns than the average long-duration debt fund and corporate bond fund. This outperformance can be attributed to the significantly lower fund management charges of NPS compared to mutual funds, resulting in higher returns for investors, states an ET report by Babar Zaidi.
“The NPS is the cheapest product available in the Indian market,” said Rahul Bhagat, CEO of DSP Pension Fund. Investors pay a mere 0.03-0.09% (or Rs 30-90 per lakh) annually, which is comparable to the charges of ETFs offered by mutual funds but significantly lower than the 1.5-2.5% charged by actively managed equity funds.

Although the fund management charges of debt funds are lower at 0.5-1.25%, they still cannot compete with the ultra-low costs of NPS funds.
While a 2% annual fund management charge may seem low, it accumulates to a substantial amount over the long term due to compounding. For example, if an investor contributes Rs 5,000 per month through an SIP in a mutual fund with a 2% annual charge, they will pay approximately Rs 19 lakh in fund management fees over 25 years. In contrast, the same investment in the NPS, assuming the maximum 0.09% fund management charge, will cost only Rs 1 lakh over the same period, assuming a compounded annual return of 9%.
Investors who do not wish to lock their money in the NPS until retirement can opt for the NPS Tier II option, which offers no tax benefits on contributions but also no withdrawal restrictions. Investments can be made today and withdrawn the next day without any exit charge. However, investing in Tier II is only possible if the investor has a regular Tier I account.
While investing in Tier II is advantageous for gilt and corporate bond funds, it may not be as beneficial for equity funds due to ambiguous tax rules. Some tax experts highlight that capital gains from investments in NPS Tier II funds may not be eligible for the favorable tax treatment enjoyed by investments in stocks and equity-oriented mutual funds.
Long-term capital gains of up to Rs 1 lakh from equity mutual funds are tax-free in a financial year, with gains beyond ₹1 lakh taxed at 10%. Short-term capital gains are taxed at 15%.
However, since no securities transaction tax is paid on NPS transactions, the investment may not qualify for these benefits. The capital gains will be added to the individual’s income and taxed at their marginal rate. “This will not suit taxpayers in the 20% tax bracket and above,” said Chartered Accountant Nishant Khemani. “The higher tax on capital gains from equity investments will take away any advantage accruing from the lower costs,” he added.