Provident Fund (PF) is one of the best fixed-income instruments. This is so because PF is the ONLY debt product (apart from PPF; but where the investment limit is just Rs.1 lakh p.a.) where the interest rate is not only quite attractive but more-importantly also â€œtax-freeâ€.
Provident Fund (PF) is one of the best fixed-income instruments. This is so because PF is the ONLY debt product (apart from PPF; but where the investment limit is just Rs.1 lakh p.a.) where the interest rate is not only quite attractive but more-importantly also “tax-free”. Secondly, there is no limit on the amount. That apart, disciplined saving every month (of course, forced discipline) is another plus point.
However, caution is advised as far as the tax-free status of this PF is concerned.
It is ‘generally’ assumed that the amount in the PF account- which comprises employee’s contribution, employer’s contribution and the interest earned thereon- is tax-free. ‘Generally’ this assumption is correct because
a) the PF amount is supposed to be withdrawn only on retirement (except for certain specified purposes); and
b) the PF amount is supposed to be transferred to the new employer as and when the job-changes happen.
But, due to the inconveniences involved, many people prefer to close their PF account with the previous employer(s) when they change their jobs; rather than transferring it to the new employer(s). This has become quite common as working with the same company for years together has nowadays become a rarity. A sharp rise in the withdrawals reported by the PF Office is a corroboration of this trend.
But beware if you propose to follow this trend!
Firstly, you can withdraw this amount ONLY IF there is a gap of at least 2 months between the date you leave your previous organisation and the date you join the new one. If not, as per law, you must transfer your PF. (This is assuming that the new company too is covered under the PF Act).
Secondly, as per Income Tax Act, “premature” withdrawal of PF balance will NOT be taxed only if you have had a continuous service of 5 years or more. [Good news is that this 5-year period will also include periods of your previous employment(s) provided you have transferred the PF balances from your previous employer(s) to the latest account.]
This 5-year condition would, however, not apply under following circumstances:
- your service was terminated due to ill-health
- your employer’s business was discontinued
- any other cause beyond your control.
Thus, under normal circumstances, you are liable to pay tax on your PF amount if the same is withdrawn before 5 years of continuous service. Therefore, it is advisable that you arrange to transfer your PF balance to your new employer(s) whenever you change your jobs and have not yet completed 5 years.
By the way, transfer makes ample sense even if you have completed 5 years and will not be taxed if you withdraw the amount. As mentioned earlier, PF offer high tax-free returns. So if were to you withdraw and reinvest this amount in any other debt product- say Bank FD or debt MF- your earnings will be taxable.
Why move out of a 100% safe, attractive and tax-free product?
In fact, PF office has now computerised the records making it much simpler for such transfers to happen. Secondly, it is also considering giving everyone a unique account number (on the lines of UID or NPS) which would be independent of the employer, thereby obviating the need to transfer at all.
Not all organisations are covered under the PF Act. So, if you join such a company, the 2-month waiting period will not apply and you can withdraw your PF balance. But the tax liability problem remains. So you may be better off to let your PF account remain as it is provided you are yet to complete 5 years of continuous service. [However, please note that a dormant PF account will earn interest only for 36 months from the time it becomes dormant. Hence, you should withdraw your PF balance when 3 years are completed.]
Sanjay Matai is a personal finance advisor ( www.wealtharchitects.in ), author and online financial trainer.