Are you saving enough towards your retirement kitty? If you are a salaried employee, you may already be investing in the Employees’ Provident Fund (EPF) that can help you create a tidy nest egg. But what if this does not suffice for your post-retirement requirement? While you cannot increase your EPF contribution beyond a level, voluntary provident fund (VPF) — an add-on to your run-of-the-mill EPF — can get you closer to your nest egg.
Here’s a lowdown on this fixed income option.
VPF is one of the best avenues to save up for retirement, under fixed income options. It is the voluntary contribution made by the employee beyond the EPF contribution. If you are a salaried employee, 12 per cent of your basic and dearness allowance is automatically deducted monthly towards your EPF contribution. The employer makes an equal contribution.
Since you cannot increase your EPF contribution beyond this level, you can consider investing your surplus in VPF. The maximum contribution towards VPF is 100 per cent of the basic salary and dearness allowance. Note that, unlike EPF, where your employer makes an equal contribution, in VPF there is no such matching contribution from the employer.
So, why is VPF an attractive option?
VPF fetches you similar rate on your investment as your EPF contribution. The Employees’ Provident Fund Organisation (EPFO) sets the interest rate on EPF every year, based on the surplus it makes in a year. The rate so far has been set higher than other similar options, making EPF and, in turn, VPF an attractive investment.
For FY19, the applicable interest rate for EPF notified by the Labour Ministry was 8.65 per cent, which was 10 basis points higher than the 8.55 per cent interest rate for FY18. The rate changes every year. For the current year (FY20) the EPFO will fix the rate by the year-end; it is likely to be higher than other comparable options, as in the past.
EPF and VPF are cumulative investment instruments, with interest getting compounded until maturity. Rules pertaining to the EPF — regarding lock-ins, withdrawal, loans and taxation — are applicable to VPF as well.
Given that bank deposits have offered 6.75-7.75 per cent interest rate over the past year, VPF is a clear winner on rates alone. It trumps the superior returns offered by small savings scheme, too. Currently, the Public Provident Fund (PPF) and the National Savings Certificate (NSC) offer 7.9 per cent. EPF/VPF can continue to fetch superior returns than your humble small savings schemes over the long run, thanks to lobbying by labour unions and the fact that EPF has been increasing its exposure to equities (pegs up the risk in the short-term).
Investment in the National Pension Scheme (NPS), which can have relatively higher exposure to equities, can fetch higher returns than VPF. But the onerous withdrawal conditions make it less friendly than VPF.
The fact that EPF/VPF investment is safe and guaranteed by the government also makes it a good vehicle for building your retirement kitty.
The tax-breaks under EPF/VPF are added advantages for investors. Such investments enjoy the Exempt-Exempt-Exempt (EEE) status. So, your investments in EPF/VPF are eligible for tax-break under Section 80C of the Income Tax Act. Interest earned and the maturity amount are also tax-exempt. This favourable tax treatment shores up the effective returns from VPF.
But one must remember that tax benefits come with strings attached. While there is no monetary limit to VPF contribution (unlike PPF contribution, which is restricted to ₹1.5 lakh per annum), there is no additional tax benefit on the investment made in excess of the Section 80C limit of ₹1.5 lakh.
Also, the interest earned in excess of 9.5 per cent per annum is taxable. In the last few years, interest rate on EPF/VPF has been within 9.5 per cent and hence the entire interest earned has been tax-free.
In case of withdrawals, EPF/VPF redemption proceeds at the time of maturity (retirement) are tax-exempt. If you withdraw before maturity, then too, the proceeds are tax-exempt, but only if an employee completes five years of continuous service.
If the amount is withdrawn before five years, and is more than ₹50,000, tax is deducted at source at the rate of 10 per cent if PAN is submitted (otherwise, it is 30 per cent). Also, interest earned and exempted from tax, until then, becomes taxable.
Since the VPF scheme is an extension of EPF, only salaried employees are eligible to invest in it. To open a VPF account, an employee must inform his/her employer about the deduction amount from the salary towards contribution to VPF through a registration form. The existing EPF account serves as a VPF account as well, and additional contributions get added to the EPF balance.
The VPF contribution also offers ample flexibility. You can stop and start it at regular intervals. However, a few employers might restrict changes to VPF contributions to just once a year.
Just like EPF, employees can withdraw the amount contributed towards VPF, too, in case of unforeseen financial emergencies. Some of the conditions for premature withdrawal include marriage or higher education of the account holder’s children, medical emergencies for self or family and construction or purchase of house.
Premature withdrawal is also allowed if you are unemployed for a certain period. Up to 75 per cent of the balance in the VPF/EPF account can be withdrawn if you are unemployed for more than a month, and the rest of the amount can be withdrawn after the second month.
EPF/VPF hence scores over PPF on ease of withdrawals as well. PPF account permits partial withdrawal (up to 50 per cent of specified amount) only after six years of contribution and full withdrawal on maturity, which is 15 years. But note that it is important not to go overboard with contributions to VPF, as it reduces your take-home salary.
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