Does EPF rate cut make voluntary provident fund unattractive?

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Over 60 million members of the Employees’ Provident Fund Organisation (EPFO) received a rude shock last week when the retirement funds manager cut the annual interest rate to 8.1 percent for the financial year 2021-22 from 8.5 percent paid in the previous year.

It is the lowest interest rate on EPF savings in 43 years, leaving contributors disappointed. Yet, it remains the most attractive, tax-efficient instrument that offers secure returns to its subscribers. EPF is exempt from tax at the investment, accumulation and maturity stages. Interest earned on EPF contributions of over Rs 2.5 lakh is subject to tax from the financial year 2021-22.

Also read: All about how interest on your EPF contributions of over Rs 2.5 lakh will be taxed

Know how VPF works

VPF, or voluntary provident fund, is simply an extension of your EPF account. Your employer mandatorily deducts 12 percent from your basic salary and dearness allowance, if any, every month to be deposited into your provident fund account. The employer contributes a matching amount to your retirement corpus, and 8.33 percent of this contribution (subject to a maximum basic pay of Rs 15,000, or Rs 1,250) is directed towards your employees’ pension scheme (EPS) account.

Apart from the 12 percent mandatory deduction from your salary, you can choose to contribute more to your EPF account voluntarily, hence the term voluntary provident fund. You can choose to direct your entire basic pay to VPF; other rules remain the same. Like EPF, this additional investment is also eligible for the same rate of return and tax benefits, but will also be subject to restrictions on premature or partial withdrawal. So, VPF, too, will earn lower returns this year, prompting some subscribers to explore other avenues.

Also read: Voluntary Provident Fund: Here’s how you can increase your retirement corpus

Why you should continue VPF contributions

Experts say you should continue your investments, meant for long-term retirement planning, through VPF. “It offers tax-free, risk-free returns, even assuming some portion is taxable. Interest rate of 8.1 percent is also quite high, and in fact, quite challenging in current times. It is hands-down a winner, no other instrument is comparable,” says Suresh Sadagopan, founder of Ladder7 Financial Advisories.

It is more attractive than other comparable instruments such as public provident fund (PPF), 10-year government securities, long-term debt mutual funds and so on. PPF offers a 7.1 percent return at the moment and the current 10-year G-sec yield is 6.85 percent.

Investing through VPF is simple too. All you have to do is study your employer’s policies and find out how to intimate your administration department and start investing. You do not have to open a fresh account or go through any know-your-customer (KYC) process. The amount or proportion that you select will be deducted from your salary, to be invested in your EPF account.

“People who have been investing through VPF should continue with their contributions. This 8.1 percent is still higher than PPF, bank fixed deposits or even 10-year G-sec yields and annuity rates offered by life insurers,” says Amol Joshi, founder of PlanRupee Investment Services.

The affluent segment with a basic annual salary of over Rs 21 lakh felt the pinch when Budget 2021 imposed a tax on interest earned on EPF contributions of Rs 2.5 lakh. Such employees could find the National Pension System (NPS) more remunerative, but Joshi believes VPF still scores. Risk-averse investors looking for secure returns would find comfort in EPF. “Beyond all this, we have to compare returns from the present day onwards. NPS’ G-sec fund returns will be similar to 10-year government securities. So, you would still be better off investing in EPF,” says Joshi.

NPS offers similar tax benefits as EPF of up to Rs 1.5 lakh under section 80C, besides an additional deduction of Rs 50,000 under section 80 CCD (1B). You can withdraw up to 60 percent of your corpus at the age of 60 as a tax-free lump-sum. The balance has to be compulsorily converted into annuities and these are subject to tax as per your slab rate, which means it’s not fully tax-exempt at all stages.