Can EPF interest help build a robust retirement corpus?
Premium- Employee Provident Fund enjoys tax benefits on contribution, interest earned and also withdrawal of funds
The Employees’ Provident Fund Organisation (EPFO), last month, fixed the interest rate on provident fund (PF) deposits for FY22 at 8.1%. Going by the EPFO’s own interest rate track record, this is one the lowest in four decades but is still attractive when compared to most fixed-income products in the market. Most EPFO subscribers would like to know how a lower interest rate affects their retirement corpus.
Credited annually
As per law, both employer and employee must mandatorily contribute 12% of the monthly payments to the EPFO, if the basic salary (and dearness allowance) is less than ₹15,000. Employers of workers with basic salary more than ₹15,000 per month can limit their contributions to 12% of ₹15,000 or can contribute 12% of the actual basic salary. Normally, 8.33% of the employer’s share is contributed to the Employees’ Pension Scheme and the remaining 3.67% is contributed to the EPF scheme.
An employee can contribute over and above 12% of the salary to the PF. It then becomes part of voluntary provident fund (VPF). Unlike EPF, there will be no equal contribution from the employer in this case. As VPF is an extension to EPF, rules with respect to interest calculation, withdrawal and taxation are similar to that of EPF.
The interest on the accumulated EPF account balance is announced and credited after the completion of a financial year at the rate recommended by the EPFO.
Even if you exit the workforce before retirement age, the balance in your PF account continues to earn interest (except when the subscriber dies or migrates abroad) till the age of 58 years, but without any tax benefit. For starters, interest on annual PF contributions until ₹2.5 lakh per annum ( ₹5 lakh if the employer’s contribution is nil) is exempt from tax.
The calculation of interest on EPF balance has three steps. Let us see how interest is calculated for FY22. In the first step, interest is calculated on the EPF balance on the last day of the preceding year. In this case, the balance in the PF account as of the end of FY21 (March 2021) is taken into consideration.
Next, in case of any withdrawals, interest from the beginning of the current year up to the month preceding the month of withdrawal is calculated. Say, you made a withdrawal (partial or full) in September 2021, interest on that withdrawal amount will be calculated from April 2021 till August 2021.
In the final step, interest on all the contributions made during the year is calculated—interest from the month succeeding the one when fund is credited to the end of the current year. So, if you put in some money in your account in April 2021, interest will be calculated from May 2021 till the end of the financial year, or March 2022, (for 11 months).
Interest calculated based on the above steps usually gets credited after a few months from the end of the financial year. Irrespective of when the PF interest is credited to your account, it is considered as credited at the end of the financial year. For example, interest on PF for FY21 was credited to the subscribers’ accounts only in December 2021. However, this interest amount for FY21 is considered part of the PF closing balance by the end of March 2021 for the purpose of calculation of interest for FY22. “Interest becomes part of the closing balance for the relevant financial year and therefore, no loss is caused to the member due to any delay in the declaration of the rate of interest," according to KE Raghunathan, who represents employers in the Central Board of Trustee.
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Further, on exiting the EPF scheme, the last declared interest will be applicable to the final payment for the outgoing members.
Retirement corpus
EPF is considered a traditional retirement savings product for silver years. Hence, the rate of interest announced each year garners a lot of attention. Irrespective of the higher or lower interest rate on PF deposits, you shouldn’t rely entirely on EPF corpus for your retirement needs.
EPF is tax-efficient with Exempt, Exempt, Exempt (EEE) status. It enjoys tax benefits on the contribution, interest earned and withdrawal, but with certain limits; from April 2021, interest earned on PF contributions over ₹2.5 lakh is taxable. Also, the employer’s contribution to the PF, National Pension System (NPS) and superannuation fund in excess of ₹7.5 lakh will be taxable as perquisites in the hands of the employee.
EPF also currently offers an attractive interest rate with a government-backed guarantee. However, experts suggest that investors shouldn’t go overboard, and suggest a combination of equity and debt for the retirement corpus. Experts also suggest investing in equity mutual funds for the long term to compensate for the deficit, if any, caused by a lower interest rate announced by EPFO.
“If someone has a target corpus to be built by retirement and, now with interest rates coming down, wants to fill in the deficit, they can consider investing in equity MFs or NPS , if the time horizon is long," said Anupama Aggarwal, senior vice president - Advisory at International Money Matters Private Ltd.
Prableen Bajpai, founder, FinFix Research and Analytics, suggests investing in broad-based index funds. “On the back of the envelope calculation, even if investors increase any of their exiting equity SIP by ₹2,000, it will be able to generate enough money to fill the gap created by the reduction in interest rates by EPFO."
Going ahead, a lower interest rate regime cannot be ruled out.
“As the economy goes forward, interest rates will gradually go down," Rushabh Desai, founder of Rupee With Rushabh Investment Services.
“When somebody young today is doing a calculation on an EPF corpus, they can expect an average of 6-7%," observed Bajpai.
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