How EPF changes over the years impact your retirement funds

Finance Minister Nirmala Sitharaman did not raise tax rates or impose new cess, but did limit the tax benefits enjoyed by the rich on interest income from Employee’s Provident Fund (EPF)  contribution. Union Budget 2021 decided to tax interest earned on EPF contributions in excess of Rs 2.5 lakh in a financial year. So, if your annual basic pay is close to Rs 21 lakh (Rs 1,73,612 a month, to be precise) or more, you will be affected by this Budget measure. Similar will be the case for those contributing beyond this threshold through the VPF (voluntary provident fund) route. You will have to evaluate other investment options and decide whether to continue with or stop making excess contributions.

The many changes in 2020

The EPFO board declares the interest rate for the financial year towards the close of the year, an event that is very closely tracked. Despite the EPFO’s central board of trustees announcing an 8.5 percent interest rate for financial year 2019-20 last March, the interest credit could be effected only in December 2020.

The Covid-induced lockdown and resultant lockdown, which wreaked havoc in equity markets, led to the delay in interest credit. Earlier, in April, Finance Minister Nirmala Sitharaman made several announcements, including allowing temporary partial withdrawals and lowering the statutory EPF contribution rate from 12 percent to 10 percent. Reduction in the statutory rate during May, June and July was aimed at putting more cash in the hands of employees who needed it.

Between April, May and June, subscribers were allowed to withdraw up to 75 percent of their EPF corpus or three months’ wages, whichever was lower, to reduce financial strain during the period. Otherwise, employees are allowed to make withdrawals  only under specific circumstances. These include funding the purchase or construction of a house, home-loan repayment, critical illness of the employee or family members, marriage of self, children and siblings, or children’s higher education.

“Employees who do not take up any other employment within two months after separation of employment can withdraw their entire PF balance in lumpsum,” pointed out Prashant Singh, Vice President and Business Head – CPO, TeamLease Services.

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

Secure returns with a dash of equity

The money that you contribute to EPF every month, along with employers’ matching contribution (minus 8.33 percent that goes towards employees’ pension scheme), is invested in debt and equity instruments. Of the incremental corpus, 85 percent is directed to secure government securities and other debt instruments, while 15 percent is invested in exchange-traded funds (ETFs).

Investments in ETFs, managed by SBI Mutual Fund and UTI Mutual Fund, are made based on the Nifty 50, Sensex, Central Public Sector Enterprises (CPSE) and Bharat 22 indices. Equity investments were first permitted in 2015.

In 2020, the EPFO central board of trustees announced an interest rate of 8.5 percent for financial year 2019-20. Of this, 8.15 percent came through income earned from debt investments and 0.35 percent from sale of equity investments by December 31, 2020.

Initially, questions were raised over the EPFO’s ability to meet its commitment of 8.5 percent, given the stock-market plunge in the wake of the COVID-19-induced nationwide lockdown from March 2020. The fund was unable to liquidate its equity investments due to volatile market conditions and  returns being negative. However, it managed to sell these investments in December as the market soared to record highs. Recently the Centre also allowed the EPFO to invest in Bharat Bond ETF.

Also read: EPFO’s poor returns from equities: Blame it on the choice of ETFs

Tax-exempt at all stages

Your contribution (12 percent of basic and dearness allowance), which is deducted from your salary every month, can be claimed as a deduction under section 80C up to the overall limit. For example, if your annual provident fund contribution is Rs 1 lakh, the entire amount is eligible for deduction as the section 80C limit is Rs 1.5 lakh a year.

If you make a voluntary provident fund contribution, that amount, too, is entitled for the deduction up to the cap. Interest accumulated over the years will also be exempt from tax. Likewise, the lumpsum that you receive at retirement is tax-free. “It is a simple and good avenue to build a retirement corpus. The amount is deducted from your salary every month automatically. The returns are assured and will suit employees who are risk-averse,” says Tejal Gandhi, Founder, Money Matters, a financial planning firm.

Also read: How the EPFO can improve as India’s largest social security provider

Employees’ pension scheme

When your employer matches your contribution of 12 percent of basic pay and dearness allowance, 8.33 percent of this amount is directed to the Employees’ Pension Fund. However, the upper limit of basic is fixed at Rs 15,000, which means that the amount transferred to the fund is capped at Rs 1,250. EPS, introduced in 1995, is a defined-benefit scheme where the payout — monthly post-retirement pension — is calculated per a formula [(pensionable salary X pensionable service)/70].

“Pensionable salary is the average monthly salary during 60 months before your retirement, as per an amendment in 2014 to the Employees’ Pension Scheme, 1995. Pensionable service refers to the number of years you have worked for (and contributed to EPS),” says Singh. It is not linked to returns generated or announced by the fund. The maximum pensionable salary is Rs 15,000, per an amendment introduced in 2014.