Retirement nest-egg: With EPF interest rate cut, voluntary provident fund loses its charm
While the Employees Provident Fund Organisation (EPFO) has proposed to lower the interest rate for 2021-22 on retirement savings to 8.1% from 8.5% in the previous financial year, the lowest since 1977-78, the rate is still higher than what an investor can earn from other fixed income schemes. The payout will have to be ratified by the finance ministry before it can be notified.
Among small savings schemes, Public Provident Fund (PPF) fetch 7.1%, Sukanya Samriddhi—a scheme targeted at the girl child—7.6%, Senior Citizens Savings Scheme 7.4%. The interest rate on SBI deposits for over five years is 5.5% and for senior citizens, 6.3%.
Many salaried employees enrolled with the EPF make voluntary provident fund (VPF) contributions over and above the statutory deductions to create a higher assured-interest-tax-free retirement corpus. But with the cut in the EPF interest rate and the tax on income from employees’ contributions above Rs 2.5 lakh, VPF may no longer be attractive. Individuals must look at alternatives like the National Pension System (NPS) to diversify their retirement kitty and earn higher tax-free returns than EPF.
The EPF way
For most salaried employees, EPF is an ideal way to save for retirement provided the subscriber doesn’t withdraw the corpus at every job change. The incremental corpus is invested in debt and equity instruments (exchange traded fund) in an 85:15 ratio. A subscriber contributes 12% of basic and dearness allowance and the employer also contributes a matching amount. Of the employer’s 12% contribution, 8.33% of the ceiling amount of Rs 15,000 a month goes towards Employees Pension Scheme, which is the pension pool. Investment in EPF gets a tax break of Rs 1.5 lakh under Section 80C, the interest earned is tax-free.
VPF or NPS?
Many individuals make voluntary contributions in EPF apart from the mandated 12% of the employees’ share. Contributions of up to 100% of the basic salary and dearness allowance can be made to VPF. The interest rate of VPF is the same as the EPF and the returns are tax-free. However, income from employees’ contributions above Rs 2.5 lakh is taxable. The limit is Rs 5 lakh when employers make no contributions. Further, contribution by employers into EPF, General Provident Fund and NPS is capped at Rs 7.5 lakh a year.
A defined contribution scheme, the National Pension Scheme (NPS) is gaining traction with investors for building a retirement kitty. Though former finance minister Arun Jaitley in his 2015-16 Budget speech said employees would be given a choice to migrate to the NPS, it remained on paper as an amendment is required in the EPF Act.
Till that happens, individuals can voluntarily invest in NPS by opening a Tier 1 account. Private sector employees can invest up to 75% of the money in equity and the rest in corporate and government debt. Returns for private sector employees are 10- 12% annually. While the returns earned from NPS are tax-free, an individual will have to mandatory buy an annuity for 40% of maturity corpus, which many investors do not find attractive as returns from annuity are around 6% and are taxed at the marginal rate of the individual.