Why you should stick to EPF despite rate cut

Buried in the middle of the rail budget drama and the build-up to the Budget speech was a tiny news item that said that the Employees’ Provident Fund (EPF) interest rate got reduced by a significant 1.25 percentage points to 8.25% for FY12. After the bumper 9.5% return last year, it was worrying for EPF account holders to read that the rate was being reduced due to a deficit in the PF kitty. You may not really need to worry. Says Rajesh Bansal, financial advisor and chief account officer, EPFO: “There has been no deficit on account of the surplus last year. There has been an estimation error on account of which there has been a deficit, this will get plugged next year.”

What happened last year?

In 2010, a surplus of Rs 1,731 crore was found by the Central Board of Trustees (CBT) and it was decided that the surplus will be passed on to the investors by bumping up the EPFO rate of 8.5% by one percentage point to 9.5% for FY11. This surplus was discovered when CBT found that the interest suspense account or ISA had a balance of around Rs 14,696 crore in March 2010. Income on investments is temporarily parked in the ISA; also, while updating members’ accounts, interest is debited from the ISA. Any balance in ISA can mean two things: a surplus or that there are some pending accounts that are unclaimed.

In order to segregate the two, EPFO did an exercise using the accrual system of accounting and calculated their actual liability since 1952, or inception, in their books till FY10. It was after accounting for these accrual payments that EPFO arrived at a surplus of Rs 1,731 crore. A reluctant ministry of finance agreed to the hike on the condition that all the pending accounts be updated within six months. This exercise has been carried out within the stipulated time frame and the surplus still holds good, confirmed an EPFO official, who did not want to be named.

What’s the problem now?

A wider perception is that the EPFO made a mistake in calculating the surplus hence the shortfall was made good by reducing the rate this year, but officials familiar with the exercise cite non-transparency, a problem that has plagued other government-run schemes in the past, and a fixed return that is declared in the beginning of the year, as the two issues with EPFO.

Says an EPFO official, who did not want to be named: “The interest in the EPFO is declared in the beginning of a financial year based on the projected income and liability. While declaring a rate for FY11, the rate of 8.5% was arrived at based on estimates and the one percentage point extra came from the surplus. This year, now that we don’t have any pending liabilities in ISA, we decided to match the estimates with actuals. We realized there was a deficit. This is why we have declared a rate of 8.25%.”

In other words, the deficit last year was on the rate of 8.5% declared in advance for the year. It is this deficit that is being accounted for in the rate this year. The surplus of one percentage point, in any case, had to go since the surplus got used up last year.

What it means for you?

Even as we wait for further clarity on the matter, a dip of more than a percentage point means your money will be earning less. But that is no reason to worry and certainly no reason to withdraw your money from EPF as it is the most tax friendly retirement corpus you can get. Your contributions qualify for a tax deduction under section 80C of the Income-tax Act. Further, if you have maintained your account for five years, the withdrawal is completely tax-free. You needn’t be in the same organization and under the same EPF account to clock up the five years. Get your accounts transferred as you move and after you have done five years, your withdrawals become tax-free.

In comparison, Public Provident Fund (PPF) is the only other debt vehicle that is backed by positive real rate of return—returns minus the inflation rate—and tax-free status. PPF is now market-linked. The rate of interest that’s declared every year will now be pegged to government securities’ (G-secs) yields of similar maturities with a spread or mark-up of 25 basis points. In other words, if the G-sec yield is 8% then the rate of interest of other instruments will be 8.25%. For this year, the rate on PPF is 8.6%, which is more than the EPF rate for the year. But the maximum that you can contribute in PPF is Rs 1 lakh.

Compare this with fixed deposit that is currently yielding as high as 9.5% on your corpus. The interest income is taxable so if you are in the 30.9% tax bracket your net return comes to 6.56%. Says Suresh Sadagopan, Mumbai-based financial planner: “The money that goes to the EPF is not generally available to the contributor, it keeps accumulating and becomes one of the best sources of funding retirement. PPF has a limit of Rs 1 lakh and given that interest rates are set to fall, PPF rate may also come down.” So keep the account funded and do not withdraw.

deepti.bh@livemint.com