PPF vs VPF: What Works Best for Building Long-Term Wealth
New Delhi: Pension plans are called pension plans. The main goal of a retirement plan is to have regular income after retirement. In view of the ever-increasing inflation, investing in these plans has become essential and a prerequisite for long-term retirement.
But two products that remain extremely popular with long-term investors are the Voluntary Provident Fund (VPF) and the Public Provident Fund (PPF). They not only offer assured and lucrative returns on investment, but also tax deduction benefits. These attractive features make these plans highly sought after by investors who want guaranteed and risk-free returns while building their retirement fund.
Let’s take a look at the difference between VPF and EPF which can help you decide whether you should go for VPF or increase the PPF contribution.
Voluntary Provident Fund (VPF)
The VPF is an extension of the Caisse de Prévoyance des Salariés (EPF). The EPF needs a compulsory contribution of 12% of the basic salary for all employees and the same amount is contributed by the employer. The Voluntary Provident Fund, as its name suggests, is a voluntary contribution beyond the threshold of 12% on PF accounts by employees. This contribution is capped at 100% of the base salary and the high cost allowance. That being said, it is important to note that your employer has no obligation to contribute to your VPF account.
Public provident fund (PPF)
The PPF is also a long-term voluntary investment plan. An investor can comfortably generate a considerable body of work for retirement due to compound growth. Investments in PPF can be made either in a lump sum or in 12 installments (of at least Rs. 500 and a total amount not exceeding Rs. 1.5 lakh) during a financial year. Interest is calculated on the minimum balance between the end of the fifth day and the last day of the month. It is therefore advisable to invest in the PPF during the first five days of the month if you are investing in installments.
Who can open an account?
VPF: Only salaried people in India are eligible to open a VPF account. It is normally opened with the EPF account to which you register when you start your work. The opening of the account is managed by the human resources or financial department of your employer.
FPP: All Indian citizens are eligible to open a PPF account. It can be opened by everyone – employees, traders, self-employed workers, even minors – in approved banks and post offices. Some large private banks also offer this possibility to investors.
VPF: The interest rate for a VPF account, which is announced annually by the government, is the same as that charged on the EPF. The interest rate for the year 2020-2021 is 8.5%.
FPP: The government sets small savings rates on a quarterly basis. The PPF interest rate is 7.1% for the July-September quarter.
VPF: Annual investment in VPF up to an amount of Rs 1.5 lakh can be used to qualify for tax deductions under section 80C of the IT Act. One can invest more than Rs 1.5 lakh, however, the additional investment will not count towards tax deductions under Sec 80C. In addition, interest earned up to a contribution of Rs 2.5 lakh (from the employee as well as the employer) will remain tax exempt. However, interest earned on the investment above this threshold will be subject to tax because interest so earned will be considered income. In addition to this, interest earned on an annual contribution of up to Rs. 5 lakh will be exempt from tax if the contributions are made only by the employee. If the employee is the sole contributor and the amount invested exceeds the threshold of Rs 5 lakh, the interest earned on the investment above the threshold will be subject to tax. In addition, if during a financial year the interest rate is higher than 9.5%, the additional interest earned will also be taxed.
FPP: The amount invested in a PPF account can be used to benefit from tax deductions up to a maximum of Rs. 1.5 lakh per year under section 80C of the IT law. Interest earned is also tax exempt. Once the mandate is completed, the total amount accumulated as well as the interest portion remain tax-free in the hands of investors.
Which one works for you?
PPF and VPF are low risk investment options and work well for investors looking for assured returns. Your decision to choose between the two depends on your time horizon and your expectations for returns. That said, it’s important to note that the rate of return for VPF is 8.5% and PPF is 7.1%, but the tax treatment of returns for the two is different.
A higher VPF contribution along with a higher interest rate can provide a faster way to build a large retirement fund. The rate of return on the PPF is set quarterly. Therefore, any increase in the interest rate will increase your tax-free returns and any decrease in the rate will reduce your returns. But it’s a great tool to invest in if your financial goals are in the 15-20 year range, like college or your children’s marriage.
People in the higher income bracket can invest in both VPF and PPF to benefit to some degree of tax-exempt interest. Note that these two instruments are not very liquid as they are intended to achieve long term goals. For the self-employed, the PPF is an effective investment option for wealth creation and tax savings. For retirement, you can also consider investing some of your savings in equity to improve your chances of building an inflation-proof fund for the future.