Personal Finance

A good choice for your nest egg

Anand Kalyanaraman | Updated on January 06, 2019 Published on January 06, 2019

VPF mirrors EPF on interest rate and almost all rules including those on lock-ins and tax breaks

It’s a big election year and the powers that be are likely to go the extra mile to keep voters of all manner happy.

Already, interest rates on small savings schemes have been left untouched for January-March, despite a dip in G-Sec rates to which they are supposed to be linked. The largesse could extend to other investment avenues, too.

Recent reports say that the Employees’ Provident Fund Organisation (EPFO) may raise or at least retain the interest rate on EPF for the fiscal year 2018-19. The rate for 2017-18 was a neat 8.55 per cent. This is good news for salaried employees contributing to the EPF.

The EPF investment is as safe as it gets, being guaranteed by the government. The interest rate is higher than comparable options, and this, too, gets enhanced by the high tax-efficiency of the instrument. The interest gets compounded until maturity instead of being paid out; this makes it a good choice for building a retirement corpus.

All these advantages are also there in the Voluntary Provident Fund (VPF) that is joined at the hip with EPF. As a salaried employee, you could already be investing in EPF — 12 per cent of your basic and dearness allowance is automatically deducted monthly towards your EPF contribution, and the employer makes an equal contribution.

While you cannot increase your EPF contribution beyond this, you can contribute more voluntarily by investing in VPF (up to 100 per cent of your basic and dearness allowance).

VPF mirrors EPF on interest rates and almost all rules including those on lock-ins and tax breaks. But there is one key difference — VPF is a voluntary investment by the employee and the employer will not make a matching contribution.

Many pluses

EPF, and by extension VPF, has several positives. One, the interest rate is the best among comparably high-safety options.

At 8.55 per cent currently, the rate is superior to the 8 per cent offered at present by the Public Provident Fund (PPF) and the National Savings Certificate (NSC). Like in earlier years, EPF and VPF could continue enjoying a higher interest rate than most debt options, though this is not certain.

The rates change every year and are fixed by the EPFO based on the surplus it makes in a year; the rate is announced towards the year-end. Lobbying by labour unions and accumulated surpluses have helped peg up the interest rates in the past. Over the past few years, the EPFO has been gradually increasing exposure to equities; this comes with risks, especially in the short-run, but could also boost returns in the long run.

Next, preferential tax treatment boosts the effective post-tax returns of EPF and VPF. The investments qualify for tax deduction of up to ₹1.5 lakh under Section 80C. The interest earned is exempt from tax and so is the maturity amount — that is, these investments come under the exempt-exempt-exempt (EEE) category.

Besides, investments in VPF are easy and flexible. You only need to inform your employer about how much you want to contribute. The amount, deducted from your monthly salary, accumulate into the EPF balance. You can stop and start the VPF contribution at regular intervals, depending on your cash flow. Some employers allow you to make changes monthly, while others allow only a few times or once a year.

Some minuses

But VPF is not for everyone. One, it is open only to salaried employees who contribute to EPF. Next, if you are seeking regular income from your investments, VPF is not a good choice as it is a cumulative instrument and the money is locked in for a long period.

Besides, while VPF offers attractive returns, don’t go overboard. The contribution reduces your take-home pay, and if you have to then borrow at high cost to meet regular expenses, it doesn’t make sense.

Also, it’s important to have an appropriate asset allocation with equity investments, too, which could deliver better than debt investments such as VPF over the long run.

Published on January 06, 2019

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