Retire Smart. VPF: Ahead of the pack

Safe, higher returns than comparable options, highly tax-efficient, a good choice for long-term corpus building — is there an investment avenue that offers all this? Say hello to the Employees’ Provident Fund (EPF) and its add-on, the Voluntary Provident Fund (VPF).

You could be investing in the EPF anyway if you are a salaried employee — 12 per cent of your basic and dearness allowance is automatically deducted monthly towards your EPF contribution, and the employer makes an equal contribution. The EPF contribution cannot be increased, but you can contribute more voluntarily by investing in the VPF. Up to 100 per cent of your basic and dearness allowance can be invested in the VPF. The VPF is joined at the hip with the EPF, earning the same rate and accumulating in your EPF account. Rules pertaining to the EPF — regarding lock-ins, withdrawal, loans and taxation are also the same.

But unlike the EPF, where the employer matches your contribution, there is no matching contribution by the employer in the VPF; it is only a voluntary investment. If you are looking for a secure, rewarding, flexible investment to add to your long-term kitty, the VPF should be high on your list. Here’s why.

Rate advantage

About a fortnight back, the Employees Provident Fund Organisation (EPFO) announced the interest rate on EPF for 2017-18 at 8.55 per cent (confirmation by the Finance Ministry is awaited). While lower than the 8.65 per cent for 2016-17 and 8.8 per cent for 2015-16, the 8.55 per cent on the EPF and, by extension, the VPF for 2017-18 is still much ahead than what comparable options offer.

For instance, the rate on Public Provident Fund (PPF) in the January to March 2018 quarter is 7.6 per cent and averaged about 7.8 per cent for the full year 2017-18. Ditto for the National Savings Certificate. Bank fixed deposits have, for the most part, given less than 7 per cent in 2017-18.

Even in earlier years, the rates on the EPF and VPF were higher than most debt options. This may continue in the future. The rates on EPF and VPF change every year and are fixed by the EPFO based on the surplus it makes in a year; the rate is announced only towards the year-end.

Unlike many other debt options, the rate fixed on EPF is not necessarily in tandem with the interest rate movements in the economy. Rates have been kept higher than other debt investments, thanks to a combination of accumulated surplus and lobbying by labour unions. With interest rates in the economy moving up, EPF and VPF rates could also go up in 2018-19, ; but this will be known only towards February or March 2019.

Over the past few years, the EPFO has taken exposure to equity, though its portfolio is still dominated by debt. Well-chosen equity investments, while they could be volatile in the short-run, have the potential to deliver much higher returns than debt instruments over a long horizon. This could widen the gap in returns between the EPF/VPF and pure-debt investments in the long term. But equity also comes with risks of declines, especially in the short term. If this happens, it could put pressure on rates in the near term. But over a multi-year horizon, equity should out-perform and bolster the return of EPF and VPF.

Tax breaks, safety

Besides relatively high rates, EPF and the VPF score on other fronts too. One, they enjoy highly preferential tax treatment. Investments in EPF and VPF qualify for tax deduction 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. This favourable treatment increases the effective returns sharply, compared with taxable options such as bank fixed deposits.

Next, EPF and VPF are as safe as they get, being guaranteed by the government; there is almost zero risk of default. Finally, EPF and VPF are cumulative investment instruments, with interest getting compounded until maturity instead of being paid out.

This feature makes the investment a good fit to build your retirement corpus. On the flip side, EPF and VPF are available only for salaried employees. Also, if you seek regular payouts or don’t want to lock in money for the long-term, they may not be suitable.

Easy and flexible

To start your VPF contribution, you only need to inform your employer about how much you want to contribute. The amount will be deducted from your monthly salary and accumulate into the EPF balance. Also, the VPF contribution is quite flexible — you can stop and start the VPF contribution again at regular intervals.

Some employers allow you to make changes monthly, while others restrict the flexibility to a few times or once a year.

While VPF is a great investment option, don’t go overboard. One, the contribution reduces your take-home pay. It’s makes no sense to invest beyond your capacity and then borrow at high cost to meet regular expenses.

Next, while debt is an important part of the overall asset allocation, be sure to have adequate equity and other investments too. Equity investments have the potential to beat debt on returns in the long run.

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