Retirement pain: With the drop in EPF rates, voluntary pension plans are losing their charm

Look at alternatives such as the national pension system to build your retirement kitty. Voluntary contributions to ETH may not be a smart move with the double whammy of lower interest rates and income tax on employee contributions above Rs 2.5 lakh

While the Employees Provident Fund Organization (EPFO) has proposed lowering the interest rate for 2021-22 on retirement savings to 8.1% from 8.5% the previous year, the lowest since 1977-78, the rate is still higher than what an investor can earn from other fixed income plans. The payment will have to be ratified by the Ministry of Finance before it can be notified.

Among the small savings schemes, the Public Provident Fund (PPF) yields 7.1%, Sukanya Samriddhi – a scheme for girls – 7.6%, the Savings Scheme for the Elderly 7.4%. The interest rate on SBI deposits for more than five years is 5.5%, and for seniors – 6.3%.

Many employees affiliated to the EPF contribute to the Voluntary Provident Fund (VPF) in addition to the compulsory deductions to constitute a larger retirement fund with guaranteed interest and tax-free. But with the ETH interest rate falling and employee contribution income tax above Rs 2.5 lakh, the VPF may no longer be attractive. Individuals should consider alternatives such as the National Pension System (NPS) to diversify their pension pool and achieve higher non-taxable returns than the EPF.

The EPF method

For most employees, the EPF is an ideal way to save for retirement provided that the subscriber does not withdraw the capital each time he changes employment. The incremental corpus is invested in debt and equity instruments (exchange-traded funds) in a ratio of 85:15. A subscriber contributes 12% of the basic allowance and dearness and the employer also contributes a corresponding amount. Out of the 12% contribution from the employer, 8.33% of the ceiling amount of Rs 15,000 per month is paid into the employees pension scheme, which is the pension pool. Investment in EPF enjoys tax relief of Rs 1.5 lakh under Section 80C, interest earned is tax exempt.

VPF or NPS?

Many individuals pay voluntary contributions to the EPF apart from the mandatory 12% on the part of employees. Contributions of up to 100% of basic salary and dearness allowance can be paid to VPF. The interest rate of VPF is the same as that of EPF and returns are tax-free. However, employee contribution income above Rs 2.5 lakh is taxable. The limit is Rs 5 lakh when employers pay no contribution. In addition, employers’ contribution to EPF, General Provident Fund and NPS is capped at Rs 7.5 lakh per annum.

A defined contribution plan, the National Pension Scheme (NPS) is gaining ground with investors to build up a retirement pool. Although former finance minister Arun Jaitley in his 2015-16 budget speech said employees would have a choice to migrate to the NPS, this remained on paper as an amendment is required in the EPF Act.

In the meantime, individuals can voluntarily invest in the NPS by opening a Level 1 account. Private sector employees can invest up to 75% of the money in stocks and the rest in corporate and government debt. Returns for private sector employees are 10-12% per year. While the returns generated by the NPS are tax exempt, an individual will be required to purchase an annuity for 40% of the maturity corpus, which many investors find unattractive as the annuity returns are around 6 % and are taxed at the individual’s marginal rate.

About Ian Crawford

Check Also

Retirement savings on PIP: How can I provide a pension for my daughter who is applying for a PIP | Personal finance | Finance

“I have a 40 year old daughter who is autistic (high scale) currently on PIP. …