When should you increase your VPF contributions?

EPF is a solid debt product but it will not be enough for your retirement.

As a salaried employee, you make regular contributions to your EPF (employees’ provident fund). This is deducted from your salary every month. Under current EPF rules, you have to mandatorily contribute 12 percent of your salary to the EPF account and your employer matches this (including the employees’ pension scheme or EPS part).

While the employer’s contribution is restricted to a maximum of 12 percent, as an employee, you can increase your contribution further through Voluntary Provident Fund (VPF), over and above the mandatory 12 percent.

Is it worth?

EPF is good but no longer fully tax-free

EPF is a solid debt product, which, if left untouched, can act as a foundation of your retirement savings. But your EPF will not be enough for retirement. You need to save more.  Many people realise this a bit late in their professional life but the sooner you wake up, the better.

How much more you should invest and where exactly would depend on what kind of an investor you are. Let’s try to answer this and how and when to increase your VPF contributions.

Also read: Avoid dipping into retirement kitty for other goals

First, remember that Budget 2021 had changed the EPF taxation rule. If the employee’s contribution to EPF (+VPF) in a year exceeds Rs 2.5 lakh, the interest on the additional amount (above Rs 2.5 lakh) will be taxable as per the employee’s income tax slab.

So, if your total contribution to EPF is Rs 4 lakh, the 8.1 percent interest earned on the excess Rs 1.5 lakh (after the first Rs 2.5 lakh) will be taxable. If you are in the 30 percent tax slab, the post-tax return will be 5.67 percent.

Since VPF is often compared with Public Provident Fund (PPF), remember PPF, at 7.1 percent, is still tax-free. But you can’t invest more than Rs 1.5 lakh per year in PPF, while there is no upper limit on VPF contributions, as such.

Now, back to our original question.

When to start or increase your VPF contribution?

Here is how to go about finding an answer to this question:

- If your annual EPF contribution is less than Rs 2.5 lakh, start VPF for an amount that results in your total (EPF+VPF) contributions reaching Rs 2.5 lakh. So, say your EPF contribution is Rs 12,500 per month or Rs 1.5 lakh per year. So, you can voluntarily invest Rs 8,333 per month or Rs 1 lakh per year in VPF. This totals Rs 2.5 lakh, and since you stay below the limit, the entire contribution earns a tax-free 8.1 percent.

- Once you have exhausted your tax-free Rs 2.5 lakh limit for EPF+VPF, you can use the Rs 1.5 lakh limit of the tax-free PPF, at 7.1 percent.

- If you still need to invest more in debt, and that too, in PF, you must further increase your VPF contributions. Since your EPF contributions will now exceed Rs 2.5 lakh, the interest on extra contributions above that will be taxed as per your tax slab.

But should you only look at provident funds (EPF/VPF and PPF) when it comes to retirement savings? Not at all.

If you are saving for retirement, which is still decades away, to save a large enough corpus that will take care of inflation, etc., you need to have a good equity exposure in your portfolio as well. Saving for retirement using just EPF (plus VPF) and PPF may result in an inadequate corpus.

Also see: List of top funds - MC30

Adding equity to retirement corpus

Suppose you are in your 40s and plan to retire  at 55. So, you have at least 15-20 years of runway. Assuming you are a balanced investor, we target a 50:50 equity-debt asset allocation. Now here is how to invest further.

- If your EPF contributions alone are 50 percent of your retirement savings, your debt allocation is taken care of. You neither need VPF nor PPF.

- But if EPF isn’t making up to 50 percent, go for VPF (and then PPF) up to an amount that helps you maintain your chosen allocation. Give cognizance to the Rs 2.5 lakh tax-free limit as discussed earlier, and, accordingly, use VPF and PPF.

-For equity allocation (50 percent in this case), start SIP in diversified equity funds from fund categories suitable for retirement, like large-cap index funds, flexi-cap funds, large and midcap funds, midcap funds, etc.

Do not unnecessarily invest in VPF till the time you have a solid equity allocation in place for your retirement portfolio.

That’s how you should decide whether or not to start/increase your VPF contributions.

Also read: NPS versus EPF: Which is the better retirement investment?