The latest budget proposed that interest earned on an employeeâ€™s annual contribution to the Employees Provident Fund (EPF) above Rs 2.5 lakh a year be taxed at the applicable tax slab.
Voluntary Provident Fund (VPF) is the contributions made by the employees that are over and above the minimum contribution set by the Employeesâ€™ Provident Fund Organisation (EPFO). However, the employer will not contribute more than 12 per cent of the basic salary, regardless of how much the employee contributes. So, many employees opt for VPF as they donâ€™t have to make any other investments and it’s easy as the amount is directly deducted from their salary.
As a result of tax on EPF contributions, there are concerns that VPF (Voluntary Provident Fund) which was hitherto a popular investment option for many employees with assured safety and tax free returns, may no longer be the favourite investment option. In such a scenario, many are looking for alternatives for employees who were investing more than Rs 2.5 lakh in EPF. But truth be told, tax or no tax, EPF is still a good vehicle for the debt portion of retirement savings. Here’s why.
Do note that the Budget proposal to tax interest on employeeâ€™s contribution to EPF of over Rs 2.5 lakh a year has not been notified yet. It could be subject to a review.
However, even if the proposal is notified as it is, the taxability of interest earned on EPF contributions will not make EPF an unattractive vehicle for your retirement savings.
There are two solid reasons why the VPF is still one of the best fixed income options. One, only the PPF offers higher interest than the VPF. But PPF has an investment limit of Rs 1.5 lakh in a year. If you want to invest more, the VPF is your best bet. Two, in the 30% tax bracket, VPF as of now would still give 5.85% returns, which is higher than what other fixed income options offer.
So far, the scheme has consistently credited more than market returns to its subscribers. The rates it has declared have also been quite resilient to ups and downs in economic conditions as well as the interest rate cycle.
Between FY15 and FY21, for example, the EPFâ€™s interest rate has dipped only marginally from 8.75 per cent to 8.5 per cent. Over the same period though, Indiaâ€™s repo rate halved from 8 to 4 per cent. The yield on the 10Â-year government bond has declined from above 8 per cent to 6 per cent.
Even assuming rates on the EPF are cut to 8 per cent for FY21, and this made taxable, this return would still compare extremely well to similar options such as the Public Provident Fund at 7.1 per cent and the GOI Floating Rate Taxable Bond at 7.15 per cent.
With the secular fall in rates arrested, one should expect returns on longÂ-term debt mutual funds to deliver lower returns over the next few years too. Therefore, tax or no tax, the EPF remains a good vehicle for the debt portion of retirement savings.
Ideally, the VPF cannot be your only avenue to save towards retirement. There are uncertainties associated with the scheme.
1. You donâ€™t know if interest rates will be aligned with markets in future.
2. You don’t know whether the scheme will see further regulatory or tax changes to discourage higher income earners.
You must diversify your retirement savings across other avenues. Consider the following:
* GOI Floating Rate bonds
* Bond offers from public sector entities
If you are to get to an adequately sized corpus by the time you retire, it would be essential to have a substantial equity component to your retirement portfolio.
In addition to your VPF contributions, consider investing in SIPs in good large and midcap, multicap or flexicap equity funds. Take the help of an advisor to track and review fund choices in future.
You can also consider SIPs in Nifty Next 50 and Nifty500 index funds.
Given that gold can smooth out portfolio returns and hedge against equity downside, some allocation to gold ETFs can be good too.
At the risk of repeating, the taxability or otherwise of the interest on VPF should only be a peripheral consideration to your retirement plan.