NPS vs mutual funds: Need your retirement savings at 35? Check withdrawal rules, lock-in periods and tax benefits

Choosing between the National Pension System (NPS) and retirement-focused mutual funds involves more than comparing returns and tax benefits. For young investors, access to savings can become equally important as financial priorities change.

While NPS comes with restrictions on early withdrawals, retirement-focused mutual funds generally allow full redemption after their lock-in period. These differences can have significant implications for investors planning to buy a home, take a career break or meet other major expenses in their 30s.

What happens if you want to withdraw your retirement savings at 35?

Under the NPS All-Citizen Model, an investor exiting before completing 15 years and before reaching age 60 is generally considered to be making a premature exit.

Sumit Shukla, MD and CEO, Axis Pension Fund, explains that subscribers making a premature exit can withdraw up to 20% of their accumulated corpus, while at least 80% must be used to purchase an annuity. However, subscribers with a corpus of up to ₹5 lakh can withdraw the entire amount.

For instance, an investor who has accumulated ₹10 lakh in NPS over 10 years and needs the money at 35 can withdraw only ₹2 lakh immediately. The remaining ₹8 lakh must be used to purchase an annuity under the premature exit rules.

The position changes once a subscriber completes 15 years.

Prithvinath Reddy, Chief Executive Officer and Director, PPFAS Pension, says that under the applicable NPS framework, subscribers completing 15 years can withdraw their entire corpus if it does not exceed ₹8 lakh.

For a corpus between ₹8 lakh and ₹12 lakh, up to ₹6 lakh can be withdrawn immediately, while the balance can be withdrawn systematically over at least six years. For a corpus exceeding ₹12 lakh, up to 80% can be withdrawn as a lump sum, with at least 20% going towards an annuity, Reddy explains.

In contrast, retirement-focused mutual funds typically allow full redemption after the prescribed lock-in period.

“While this provides flexibility, it also places greater responsibility on investors to preserve those savings for retirement,” Reddy says.

Can you withdraw money from NPS without closing the account?

NPS allows partial withdrawals for specified financial needs, although restrictions apply.

According to Shukla, subscribers can withdraw up to 25% of their own contributions after completing three years. These withdrawals are permitted for purposes such as children’s education or marriage, purchasing a house, medical treatment and certain other eligible financial obligations.

Shukla explains that up to four partial withdrawals are permitted before age 60, subject to the applicable conditions, including a four-year interval between withdrawals.

Importantly, the 25% limit applies to the subscriber’s own contributions rather than the entire accumulated corpus, which also includes investment returns and any employer contributions.

Retirement-focused mutual funds, meanwhile, typically have a lock-in period of five years or until the stipulated retirement age, whichever is earlier.

Shukla says investors can redeem their entire holdings once the lock-in ends, without being required to purchase an annuity. However, each fresh investment has its own lock-in period, meaning some units may remain locked even when earlier investments become eligible for redemption.

Reddy points out that the restrictions under NPS are intended to ensure that part of the accumulated savings continues to generate income during retirement.

NPS vs retirement mutual funds: Which offers better tax benefits?

Taxation is another important consideration when choosing between the two investment options.

Shukla explains that under the old income tax regime, eligible personal NPS contributions qualify for deductions under Sections 80CCD(1) and 80CCD(1B).

Under the new tax regime, the principal benefit for eligible salaried employees comes from employer contributions under Section 80CCD(2), subject to the applicable limits, including the 14% salary ceiling.

However, Shukla cautions that tax benefits should not be the sole reason for choosing NPS, particularly for younger investors whose financial commitments may change.

He points out that although NPS permits larger lump-sum withdrawals under certain exit conditions, the tax exemption currently extends to up to 60% of the total corpus on exit. Any additional lump-sum withdrawal is subject to applicable taxation, while annuity income is taxable when received.

Retirement-focused mutual funds do not offer the same NPS-specific contribution benefits. Gains on redemption are taxed according to the fund’s classification and applicable capital gains rules.

Shukla believes investors should first maintain an emergency fund and make separate provisions for goals such as buying a home, pursuing higher education or taking a career break.

NPS, he says, is best suited for money genuinely earmarked for retirement, where restricted access can help investors remain disciplined.

Should you choose NPS, retirement mutual funds or both?

Both experts favour combining investment options rather than relying entirely on one retirement product.

Shukla believes NPS can form the core of a retirement portfolio because of its relatively low costs, regulated asset allocation, tax efficiency and long-term investment discipline.

A retirement-focused mutual fund can complement NPS by providing greater liquidity after its lock-in period, although redemption may attract capital gains tax.

According to Shukla, investors with irregular income or major financial commitments in the coming years may begin with a smaller NPS allocation and gradually increase their contributions as their financial position improves.

Reddy also believes retirement savings should not be postponed entirely because of competing financial obligations.

“Retirement is a financial goal for which no loan will be available when the time comes,” he says.

He suggests that investors managing substantial EMIs should continue making retirement contributions, even if the amounts are relatively small, and increase them once their liabilities reduce.

Reddy recommends building a retirement portfolio using different products. EPF and PPF can provide a relatively stable fixed-income foundation, NPS can support disciplined, market-linked retirement accumulation, and mutual funds can offer flexibility across financial goals.

For young investors, the choice ultimately depends on how much money they can afford to keep untouched until retirement.

NPS may be more suitable for savings firmly earmarked for retirement, while retirement-focused mutual funds provide greater flexibility once their lock-in period ends. Investors expecting major expenses in their 30s or 40s should account for those needs before committing a substantial portion of their savings to either product.