Until now, one of the best savings and investment option for a salaried person was investment in the employees’ provident fund (EPF) scheme. It inculcates the habit of compulsory savings with a relatively higher interest rate backed by government when compared to other similar investment options. It also provided tax-free income in the hands of the investor.
However, as per union budget 2021-22, interest earned on employee contribution (statutory and voluntary) beyond Rs 2.5 lakhs in a financial year will now be taxed as per income slab of the taxpayer. Further, there are conditions where employer is not under obligation to contribute for EPF under the law e.g., government employer where the contribution goes to pension fund. In such cases, if employee is contributing voluntarily to provident fund, interest on such contributions by employees will be exempt from tax beyond Rs 5 lakhs in a year. It means that this enhanced limit will largely benefit government employees or cases where employers are not contributing for EPF.
The rationale for introducing this tax is to restrict the practice of parking large amount of funds which enjoys higher interest rates along with tax exemption. This will affect high salaried people who use to enjoy this tax exemption without any limit.
From the investment management perspective, if the employee’s mandatory contribution to EPF is more than Rs 2.5 lakhs in a year, then there is no choice. The new tax is applicable directly. However, if a person is voluntarily contributing and has flexibility in making this contribution, he can check his post tax returns before taking any decision. Alternatively, he can explore some other investment options.
At present, interest on EPF investment is 8.5% and if someone is under 30% tax bracket, post tax return comes to 5.95% which is still better than similar non-risky options such as bank FDs, bonds and NCDs. The other investment options for retirement that can give higher post tax returns is investment in Public Provident Fund (PPF) and National Pension Scheme (NPS).
The investment under PPF provides tax deduction under section 80C and interest earned is also tax exempt. The current interest rate is 7.1% which is higher than post tax EPF returns but it has investment limit of Rs 1.5 lakhs in a year.
NPS offers market-linked returns where investors can choose asset allocation between equity and debt. It matures at the time of retirement and at that time investors can withdraw 60% of the NPS corpus tax-free while the balance 40% is used to buy annuity product that provides taxable regular pension. NPS funds have generated very attractive returns somewhere in the range of 9-12% and can be considered as a good retirement option. It also offers additional tax deduction of Rs 50,000 at the time of investment.
The selection of investment product for retirement differs from person to person based on their age, income structure, risk profile etc. Employees with higher savings looking for building a retirement corpus will have to rework on their investments, especially, those who were putting higher contribution to voluntary provident funds. If available, one can utilize the EPF contribution limit of Rs 2.5 lakhs and then create a combination of PPF and NPS depending upon their requirement and preference. Going forward, we see investors moving their voluntary PF investments to other alternatives, largely to NPS for meeting their retirement goal.