Amidst the intense market volatility lately, your employee provident fund (EPF) account is silently earning you a decent interest income, building up your retirement corpus.

But have you ever paid attention to the rate at which the interest amount was calculated, when it was credited, when your account stops earning interest, or how will the interest amount be impacted by the dates on which monthly contributions or emergency withdrawals are made from the account?

Here’s a look at the nitty-gritty of the interest payable on EPF accounts.

Decent returns

The interest on the accumulated EPF account balance is credited annually after the end of the financial year at the rate recommended by the retirement fund body ― Employees’ Provident Fund Organisation (EPFO), in consultation with the Finance Ministry.

If the PF accounts are settled before the completion of a financial year, interest till the withdrawal period is understood to be paid at the rate applicable to the previous financial year.

For FY20, the EPFO has recommended an interest rate of 8.5 per cent, lower by 15 basis points compared to the interest rate applicable for FY19. This interest rate is yet to be approved by the Ministry of Finance.

The 8.5 per cent interest rate for EPF, which is also a seven-year low, was set by the EPFO on the back of subdued earnings from its investments in the lower interest rate cycle over the last one year.

Interest on EPF accounts is usually better than the returns offered on most small savings schemes. For instance, for FY20, small savings schemes such as public provident fund scheme (PPF) and National Savings Certificate, offered interest rates in the range of 7.9-8 per cent.

Method of calculation

To make the most of your provident fund investments and earn higher interest income, it is important to understand how the interest is calculated on the EPF balance which includes both employers’ and employees’ contribution.

The interest compounds annually and is calculated based on the monthly running balances in the way as explained in the following example.

Say, your EPF balance as on March 31, 2019 was ₹8 lakh. Assume, during the financial year 2020 (April 1, 2019 to March 31, 2020), monthly PF contribution to the account was ₹6,000 (on the 30th of each month). Suppose, interest amount of ₹60,000 pertaining to FY19 was credited into the EPF account on August 15, 2019. Say, you also made a withdrawal of ₹3 lakh on September 15, 2019. Now, here’s how the interest receivable for FY20 will be calculated, if the rate of interest fixed for the year is 8.5 per cent.

First, interest for 12 months is calculated on the amount at the credit of a member on the last day of the preceding year plus interest credited during the year pertaining to the preceding year, minus any sums withdrawn during the current year. That is, interest of 8.5 per cent on ₹5.6 lakh (₹8 lakh + ₹60,000 – ₹3 lakh) will be ₹47,600.

Then, on the sums withdrawn during the current year — interest is calculated from the beginning of the current year up to the last day of the month preceding the month of withdrawal. Going by this, interest on the above withdrawal of ₹3 lakh will be calculated from April 1, 2019 to August 31, 2020 – five months. This would amount to ₹10,625 (₹3 lakh*8.5 per cent*(5)/12).

From this, it is understood that, in case of withdrawals, interest is calculated not until the withdrawal date but only till the last day of the month preceding the month of withdrawal. Thus, unless necessary, any withdrawals from the PF account can be planned to be made at the beginning of the month to lessen the opportunity cost.

And, on all the sums credited to the member's account (except credit of interest) after the last day of the preceding year — interest is considered from the first day of the month succeeding the month of credit to the end of the current year. In the above case, interest on monthly PF contribution of ₹6,000 will be calculated from the following month of deposit till the end of the year (that is, 11 months’ interest for PF contribution in the month of April, 10 months’ for May’s contribution, nine months’ for June’s contribution and so on..). This would amount to interest of ₹2,805.

Thus, the interest receivable on the EPF balance for FY20 would be about ₹61,030 (₹47,600 + ₹10,625 + ₹2,805).

Though credits to the PF account are not in your control, understand that your employer transferring the monthly PF contribution at the end of that relevant month is beneficial over transfer at the beginning of the next month. That’s because, interest on additions to the account will be calculated from the first day of the month following the month of credit.

Inoperative account

Under the regulations of Employees’ Provident Fund Scheme, 1952, interest shall not be credited to the account of a member from the date on which it becomes an ‘inoperative account’.

An account is considered inoperative if the subscriber either retires from service after the age of 55 years or migrates abroad permanently or dies; and application for withdrawal is not made within the next 36 months (or three years).

That is, in the above cases, interest will be credited to the PF account only until three years from the time fresh contribution to the account is stopped.

In most of the other cases, EPF account continues to be operative and interest will be paid until the subscriber attains the age of 58 years, provided application for withdrawal was not made before that. This category includes cases of voluntary retirement before the retirement age.

Earlier, a PF account with no fresh contribution for three years continuously, was also considered an inoperative account. For instance, if a person quits work before the retirement age of 55 years, interest was paid on the PF account only until the next 36 months beginning from the month there was no contribution.

This rule was not beneficial to those who quit work at an early stage but wish to retain the balance in the EPF account for retirement time.

However, EPFO rules were changed with effect from April 2016, whereby the definition of inoperative account was altered, allowing those who quit work before the retirement age of 55 years, too, to receive interest till the age of 58 years.

Note that, in such cases, the benefit of tax exemption on the interest income will not be available. Income Tax rules imply that the interest earned on EPF accounts is exempt only as long as the relationship between the employer and the employee exists.

Interest rules

  • Credited after the end of a financial year
  • Calculated based on the monthly running balances
  • Shall be paid up to 58 years of age even in case of no fresh contributions