Why NPS rule changes may not pull long-term money away from mutual funds

Recent changes to the National Pension System (NPS) have made the retirement product more flexible, but they are unlikely to significantly divert long-term investor flows away from mutual funds, according to Mrin Agarwal, Financial Educator and Director at Finsafe India.

Why the NPS rules changed

Agarwal said the updated NPS exit and withdrawal norms mark a structural shift aimed at improving investor flexibility and participation. “It’s literally like a makeover on the NPS,” she said, pointing to key changes such as extending the investment age to 85 years, removing the mandatory five-year lock-in for certain exits, and allowing greater access to accumulated savings before retirement.

The changes are intended to make NPS more adaptable to evolving retirement needs, especially as life expectancy and working years increase.

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How the new withdrawal rules work

Under the revised framework, subscribers can now exit NPS after 15 years or at the age of 60, whichever is earlier. If the total corpus is up to ₹8 lakh, investors can withdraw the entire amount as a lump sum without purchasing an annuity.

For corpuses above ₹12 lakh, up to 80% can now be withdrawn as a lump sum, with only 20% required to be invested in an annuity—down from the earlier 40% requirement. This significantly increases liquidity at retirement.

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Why mutual funds may not lose flows

Despite the added flexibility, Agarwal said NPS remains fundamentally a retirement-focused product, while mutual funds continue to offer superior liquidity and flexibility. “There’s still a 15-year lock-in here versus mutual funds, where you don’t have any lock-in at all,” she said.

She added that while the changes may prompt investors to re-evaluate NPS, they are unlikely to trigger a major shift away from mutual funds. Although mutual funds can also be used for retirement planning, maintaining long-term discipline remains a challenge for many investors.

Commenting on the higher lump-sum withdrawal limit, Agarwal said some investors may still prefer equity mutual funds for long-term wealth creation due to greater control over investments. At the same time, she noted that NPS lock-ins help enforce savings discipline. “The lock-in actually works in favour of the product,” she said.

Tax treatment remains largely unchanged

Agarwal clarified that the tax treatment of NPS has not changed. Sixty percent of the corpus remains tax-free at exit, while the additional 20% withdrawn under the revised rules is taxable at the investor’s applicable slab rate. The remaining 20% invested in annuities continues to generate taxable pension income.

She added that investors are awaiting further clarity on whether future tax changes could accompany the enhanced withdrawal flexibility.

What older investors can consider

For investors aged 50 and above, Agarwal suggested continuing with NPS if already invested and using systematic withdrawals rather than opting for a full lump-sum exit. She highlighted that NPS automatically increases debt allocation with age, which may suit retirees seeking lower volatility.

She added that effective retirement planning typically involves multiple instruments, including NPS, the Employees’ Provident Fund (EPF), and mutual funds, with the mix depending on individual income and liquidity needs post retirement.

For the full interview, watch the accompanying video

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