Category: Personal Finance

Maximum safety for the corpus, fixed returns and tax-free status at the time of investment (up to ₹1.5 lakh), on interest accumulated as well as on the maturity proceeds make EPF among the most efficient instruments for building long-term savings.

However, tweaking EPF norms in the Budget and outside of it has been the practice in the last few years. This year is no different, with the Budget proposing taxation of interest on employees’ contribution over ₹2.5 lakh to provident funds, made after April 1, 2021. While this move is targeted at high-income earners according to the government, the tweaking of EPF rules over the years holds a lesson for all classes of investors – don’t put all your eggs in one basket.

Target of changes

EPF has been the favourite tinkering target for many years now, bringing uncertainty to retirement planning based on EPF alone. Budget 2016 originally proposed that only 40 per cent of the EPF corpus will be tax-free (for corpus from contributions made beginning April 1, 2016), only to roll back the much-criticised move. A monetary limit of ₹1.5 lakh for employer contribution (for taking tax benefit) was also proposed and withdrawn.

In Budget 2020, employer contribution towards recognised provident fund, NPS and other superannuation funds was prescribed an upper limit of ₹7.5 lakh, beyond which it would be taxed as perquisite in the hands of the employee. Accretions to this, such as interest or dividend to the extent of the employer’s contribution included for tax purposes, is also taxed.

The Employee Pension Scheme (8.33 per cent of the employers’ matching 12 per cent contribution goes here ) was withdrawn for new employees who joined the workforce after September 1, 2014 and whose basic pay plus dearness allowance (DA) exceeded ₹15,000 per month. Also, pensionable salary was subject to a cap of ₹15,000 for those joining after September 2014. Prior to that, higher contribution was allowed at the option of the employer and employee. (matters remain sub-judice, though).

VPF attraction dims

A back of the envelope calculation shows that an income (basic pay and dearness allowance (DA)) of about ₹20 lakh a year, at 12 per cent, will fetch an EPF contribution of about ₹2.5 lakh. Thus, the government’s defence to taxing interest on EPF contribution over ₹ 2.5 lakh is that it is targeted at the high-income group. But directionally, this move discourages Voluntary Provident Fund (VPF) contributions as even those earning below ₹20 lakh could be using the VPF route to invest further in the EPF. Up to 100 per cent of the basic pay and DA can be contributed to the VPF in a year by an employee, over and above the 12 per cent contribution to EPF. Earning the same interest rate as the EPF, the VPF provides a risk-free, tax-free route to further build your retirement corpus if you are an EPF subscriber. The attractiveness of the VPF now dims for these investors.

Return uncertainty creeps in

Not only that, the ability of the EPFO to give returns unconnected with the market situation is being put to test lately. In what was perhaps the first time, the EPFO last year declared that it would pay the promised interest of 8.5 per cent for FY20 in two instalments, split as 8.15 per cent from debt investments and 0.35 per cent from the equity portion.

Until sometime ago, the EPF contributions were invested entirely in debt instruments. The EPFO began investing in the stock market in 2015. About 15 per cent of the incremental flows is in now invested in the stock market through the ETF (exchange-traded fund) route. When the EPFO declared an interest rate of 8.5 per cent for 2019-20 earlier , the idea was that it could offload its ETF holdings to the necessary extent to fund this interest outgo. But the market sell-off due to the Covid-19 outbreak at the fag end of the financial year spoilt the plan. Thus, stock market investments have now brought an amount of uncertainty to returns and this factor is here stay.

Also, the EPFO’s practice of higher interest payouts on the debt portion when compared to the prevailing market interest rates — which has quite been the norm so far – may not carry on forever, as interest, declared from the surplus available may not mirror the returns made by its underlying portfolio. The stock market exposure accentuates this divide.

Pat for NPS

While EPS has been losing sheen in many ways, the National Pension System (NPS), which is a market-linked retirement product, has been in the spotlight. As early as Budget 2015, the then Finance Minister spoke of bringing out a mechanism to help employees migrate from EPF to the corporate NPS scheme, clearly bringing out the government’s preference to shift the burden from their shoulders. This was followed by providing an additional deduction of ₹ 50,000 from taxable income for NPS investments, over and above the ₹1.5-lakh 80C deduction limit in the same budget.

Budget 2016 declared the 40 per cent of the NPS corpus that is compulsorily invested in annuities, tax-free (annuity income taxable). Budget 2019 declared the remaining 60 per cent that can be withdrawn in lump sum, also tax-free. Returns earned on NPS contributions are tax exempt as well (except on employer contribution in case of corporate NPS over a certain limit). These factors should serve as a wake up call for investors who until now could take low risk and earn high returns. The time to sweat it out has arrived.