Here's how your Employee Provident Fund can beat equity

EPF vs Equity

When I told a client that her Employee Provident Fund (EPF) earning 8.25 percent could beat her equity investments returning 16 percent, she almost laughed. “That can’t be possible,” she said until we did the math together.

Here’s how EPF works: If you’re salaried and covered under EPF, you contribute 12 percent of your basic salary and your employer matches that with another 12 percent. The interest rate on PF is 8.25 percent. EPF withdrawals are tax-free if held for more than five years.

EPF taxation

EPF enjoys a rare EEE status — exempt on investment, exempt on growth and exempt on withdrawal.

Employee contributions: Your contribution qualifies for deduction under Section 80C (old tax regime).

Employer’s contribution: Not added to your taxable income in both old and new tax regime.

Interest earned: Completely tax-free after 5 years of service.

That said, two important limits apply:

Employer contributions cap: If combined employer contributions to PF + NPS + superannuation exceed Rs 7.5 lakh in a year, the excess is taxed as a perquisite.

High employee contributions: If your PF/VPF contributions exceed Rs 2.5 lakh a year, interest on the excess becomes taxable.

For someone with a salary up to Rs 40 lakh (basic salary is generally 50 percent of CTC i.e. Rs. 20 lakh), none of these restrictions would apply as the 12 percent contribution would be below Rs 2.4 lakh.

Let’s do the math with this example.

Consider two colleagues, Radha and Madhu, each with a CTC of Rs 26 lakh and a basic salary of Rs 1 lakh a month. Both of them opted for new tax regime. Radha contributes the full 12 percent of her salary to EPF — Rs 12,000 a month—matched by her employer, bringing her total monthly investment to Rs 24,000.

Madhu, on the other hand, opts out of EPF so her taxable salary increases by Rs 12,000 a month (employer’s PF share). After paying Rs 3,744 in tax on the increased portion of salary, she is left with Rs 20,256 (Rs 24,000 – Rs 3,744) to invest in equities every month.

Both of them invested for five years. Radha earns a steady 8.25 percent pa on her EPF while Madhu generates a CAGR of, say, 11 percent. At the end of five years, Radha’s EPF corpus is Rs 17.75 lakh and Madhu’s portfolio has grown to Rs 16.10 lakh. Madhu will end up paying Rs 35,000 tax on the long-term capital gains. Her post-tax corpus will be Rs 15.75 lakh.

Despite equities compounding at a higher rate, Radha comes out ahead because EPF gives her a higher net investment, guaranteed stability and complete tax efficiency. For Madhu to beat Radha in a five-year time frame, her equity portfolio would need to deliver a sustained 16 percent CAGR, not easy to get consistently even in equity.

Let’s understand how much returns an equity fund would need to compete with PF over longer time frames.

Do bear in mind that the Employee Pension Scheme (EPS) deduction by the employer is affected by the salary threshold of Rs 15,000, which was introduced in September 2014. Earlier, the limit was Rs 6,500. Employees joining after September 1, 2014, with a salary (basic + DA) exceeding Rs 15,000 are not eligible for EPS membership, and their contributions are directed solely to the EPF. There is also the hassle of EPF withdrawal, while it is much easier to withdraw money from mutual funds. Also, the return is government-dependent in EPF but guaranteed.

PF alone is not sufficient for a retirement corpus. You also need equity and other asset classes. I’m not suggesting that one ignore equity. Equities remain the engine for long-term wealth creation. PF is arguably one of the best investments a salaried person can make —stable, tax-efficient, and effortless. So, embrace equity but don’t ignore PF. If you opted out of PF or are just contributing the minimum Rs. 1,800 a month, you may have underestimated this math.

(The writer is a chartered accountant and is the founder of Nimit Consultancy )