The Employees’ Provident Fund, or EPF, is a retirement fund for organised sector employees, managed by the Employees’ Provident Fund Organization, or EPFO.
Under the EPF scheme, an employee has to pay 12% of basic salary (plus dearness allowance) every month, and an additional 12% is contributed by the employer. In total, 24% goes towards the EPF account.
The Voluntary Provident Fund, or VPF, is if employees want to contribute over and above the mandatory amount. The employer does not contribute towards this.
While contributions to EPF fall under Section 80C of the Income Tax Act, contributions to VPF do not qualify. Yet, individuals go ahead because of the safety of the instrument (backed by the government), because of the assured rate of interest, and tax-free interest.
The changed EPF rule.
Now, if the employee’s contribution to his or her EPF and VPF exceeds Rs 2.5 lakh in a year, the interest above that amount will be taxable as per employee’s income tax slab. This only takes into account the employees’ contribution and not employer’s (or the total contribution).
If your total provident fund contribution (both mandatory and voluntary) is more than Rs 2.5 lakh, then the interest earned on the excess amount will be taxable as per your slab now. This move is expected to specifically impact high-income salaried individuals.
Does it make sense?
Recent articles in Mint and Economic Times threw up some interesting figures on EPF accounts.
- There are around 1.2 lakh HNI accounts
- 1 individual has more than Rs 103 cr in his account
- 2 individuals have more than Rs 86 cr each in their accounts
- The top 20 HNIs have around Rs 825 cr cumulatively in their accounts
- The top 200 HNIs have over Rs 2,000 cumulatively in their accounts
- The average corpus for an HNI is Rs 5.92 cr, which amounts to average tax-free annual earnings of Rs 50 lakh
It is little wonder that the Union Budget 2021 changed the provident fund interest taxation rule.
Why it is still a great investment.
Let’s say your mandatory EPF contribution (employee contribution) is Rs 20,000 per month. But you also opted for VPF of an additional Rs 30,000 per month. Now your total monthly contribution is Rs 50,000, or Rs 6 lakh per annum. Above the Rs 2.5 lakh, the balance Rs 3.5 lakh will be taxed.
The 8.5% return on the Rs 3.5 lakh is Rs 29,750. On this amount you will pay tax, according to the slab you fall under, which is most probably 30%.
(The calculation is simplistic and merely illustrative. EPF interest is computed monthly but deposited only once at the end of the financial year. Hence, the exact amount shall vary.)
If you belong to the highest tax bracket, you still get close to 5.95% post-tax returns (30% tax on 8.5% interest) on interest on contributions above Rs 2.5 lakh.
For the amount below Rs 2.5 lakh, it is still 8.5%, and is tax free – EEE (deposited amount is exempt from tax, interest earned is exempt, maturity amount is exempt from tax).
All said and done, in the current low interest scenario, the assured fixed return, the safety of the instrument, and the tax structure, it is still a very good avenue to invest in.
The best part, that still needs to be clarified.
The new taxation is applicable only in the year in which you actually contributed more than Rs 2.5 lakh. From the next year onwards, any interest you earn from this excess amount (or interest on interest from previous year’s excess amount) will be tax-free like earlier.
Let’s refer to the earlier example. then the 8.5% interest earned on the excess amount of Rs 3.5 lakh, which was Rs 29,750 will become part of the principal from next year. And hence, this will not be taxed the next year and the subsequent years.
However, clarity is still awaited on this front.
