In the latest budget, interest earned on an employee’s annual contribution to the Employees Provident Fund above ₹2.5 lakh a year is proposed to be taxed at the applicable tax slab. As a result, VPF 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, what alternatives do you suggest for employees who were investing more than ₹2.5 lakh in EPF? Please suggest investments that could be in SIP mode with similar post tax returns as the EPF, which are completely safe.

Santosh Sinha

Do note that the Budget proposal to tax interest on employee’s contribution to EPF of over ₹ 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.

So far, the scheme has consistently credited above-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 instance, the EPF’s interest rate has dipped only marginally from 8.75 per cent to 8.5 per cent. Over the same period though, India’s repo rate has halved from 8 to 4 per cent. The yield on the 10-year government bond, a comparable instrument 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 (there’s talk of reduced rates) and this is 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, you should expect returns on long-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 your retirement savings.

But having said this, the VPF cannot be your only avenue to save towards retirement. There are uncertainties associated with the scheme. You don’t know if interest rates will be aligned with markets in future, whether its equity component will outperform alternatives and whether the scheme will see further regulatory or tax changes to discourage higher income earners from parking with it. To deal with these, you must diversify your retirement savings across other avenues such as PPF, GOI Floating Rate bonds and bond offers from public sector entities too. Besides this, 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. Ideally, if you have ten plus years to go to retirement, you can go with a 60 per cent or higher equity allocation.

In addition to your VPF contributions, we would suggest investing in SIPs in good large and midcap, multicap or flexicap equity funds. We think Mirae Asset Emerging Equities, Kotak Flexicap are good choices currently, though you may need the help of an advisor to track and review these choices in future. You can also add SIPs in Nifty Next 50 and Nifty500 index funds to add a mid-cap kicker to your returns. Given that gold can smooth out portfolio returns and hedge against equity downside, a 5 per cent allocation to gold ETFs would also be desirable. You can acquire this through SIPs.

Use the services of an advisor or a retirement calculator to find out the approximate corpus you would need to accumulate towards retirement. Work out the yearly investments you would need, and then divide this into equity and debt components. The taxability or otherwise of the interest on VPF should only be a peripheral consideration to your retirement plan.

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