The Employee Provident Fund law was formed in 1952 to be a social security scheme for the salaried class. It was assumed that given our propensity to consume and to postpone our savings, we would leave our retirement planning until too late.
In other words, it was a form of 'forced saving' introduced by the government to take care of salaried employees' future.
Under the law, employers are required to cut 12 per cent of the sum of basic pay and dearness allowance from the employee's salary, and match this amount from their own funds and invest all of this in EPF for the employee. A part of the employer's contribution (about Rs 541 goes towards Employee Pension Scheme or EPS if you are earning Rs 6500 a month or more).
The rate of interest earned on the provident fund is fixed by the central government in consultation with the Central Board of Trustees, Employees' Provident Fund, every year during March or April. The interest is credited to the member's account on monthly running balance with effect from the last day in each year.
As an investment product, it currently offers 8.5 per cent per annum. Compare it with other fixed instruments and one can clearly see the difference (<B>See Tax Impact</B>).
And the way economics and politics is run in our country, it wouldn't be wrong to assume that EPF interest rates would continue to remain higher than other fixed investments in the future as well. Moreover, there are other parameters as well that make it an attractive proposition such as:
Safety - Since it is backed by the government of India, it probably the safest investment around.
Volatility - Rate revision is considered only once a year.
Tax benefit - Much like PPF, EPF too offers benefit while investing, earning and withdrawal phase. In taxation parlance, this is called EEE (exempt at investing, earning and at withdrawal).
Withdrawal - Other than at retirement, you are allowed to withdraw funds for medical care, housing, family obligation, education of children and financing of insurance polices. Even at the time of changing jobs, you can transfer it to the new employer.
What more could one ask for?
So, let us see how it works. Assuming that you are 23 years of age and just starting contributing to EPF. Also, you intend to retire at 58. For starters you are earning Rs 100,000 per year (basic salary + dearness allowance). Assume a salary hike of 10 per cent per annum.
| TAX IMPACT | ||
| Pre tax | Post Tax | |
| PPF | 8.00% | 8.00% |
| FDs | 9.50% | 6.36% |
| EPF | 8.50% | 8.50% |
| Note: Income tax bracket is taken at the rate of approximately 33% | ||
We also have a fairly conservative assumption that the interest rate on provident fund, which is 8.5 per cent per annum, keeps falling by 0.5 per cent every two years and stabilises at 5 per cent per annum. Under this calculation, by the time you retire, you would have a corpus of Rs 1.21 crore (Rs 12 million). You have the option of withdrawing this amount and investing anywhere. Also, it is completely tax free.
Besides the lumpsum, he would also get a pension of Rs 3,400 per month from the money that was going into the pension scheme (8.33 per cent of the employer's contribution with a maximum limit of Rs 541 per month).
Of course, there is an option that you can invest more that 12 per cent of your salary in the EPF account. However, given that the tax benefit under section 80C limits you to Rs100,000, often it does not make sense to deposit more in it.
Once you retire, with the corpus of Rs 1.21 crore you can purchase a monthly annuity (technically called 'immediate annuity') from any insurance company. Of course, it depends on the number of years that you want the pension for. That is, if you want pension for the next 22 years (up to age 80), you could get a monthly pension of Rs 78,845 (at 5 per cent), Rs 85,857 (at 6 per cent) and Rs 93,170 (at 7 per cent).
Another important point is that the amount standing to your credit in the provident fund cannot be attached under any decree or order of any court in respect of any debt or liability. Even in case of death, the full amount comes to the nominee. Very few investments have this protection.
However, one needs to remember that if one closes an EPF account then one has to start all over again. Unlike other investment options, the Employee Provident Fund Organisation does not allow you to put that money back in.
Also, if you stay invested, you will be exempt from tax on withdrawals after a continuous contribution for five years or more, through one or more employers. A withdrawal would attract tax on the entire interest earned and the employer's contribution in the year of withdrawal. But, the portion of withdrawal pertaining to the employee's own contribution is not taxable.
To sum up, EPF is a good investment vehicle, which ensures that you have ample funds to lead a comfortable life after you retire.
The writer is director Acorn Investment Advisory Services
