Ramesh Pathania/Mint
Ramesh Pathania/Mint

Despite a rate cut, EPF a good fixed income option

Even after the reduction, EPF continues to be an important vehicle in the debt space for long-term goals such as retirement

In a move that will have an impact on the savings of about 170 million subscribers of the Employees’ Provident Fund, the Central Board of Trustees of the Employees’ Provident Fund has recommended a rate of 8.65% for the year 2016-17, which is 15 basis points (bps) lower than 8.8%, which was the return that your EPF savings earned in 2015-16. This is, however, still 216 bps more than the 10-year government bond (security) yield, and above the Public Provident Fund (PPF) rate of 8%. One basis point is one-hundredth of a percentage point.

The Reserve Bank of India (RBI) has reduced the policy rates by 175 bps since January 2015. With the overall interest rates on a decline, the return on EPF corpus is better than that of traditional instruments such as fixed deposits (FDs). State Bank of India Ltd offers 6.5% interest on its 5-year FD.

“If your (basic) salary is over Rs15,000, you don’t have an obligation to contribute to EPF. But many employees still do because of the tax incentives available. EPF currently operates on EEE (exempt, exempt, exempt) model," said Naveen Wadhwa, deputy general manager-R&D, Taxmann, a tax and accounting firm.

Even after this cut, the rate on EPF is attractive compared to FDs, National Savings Certificate, government bonds and PPF.

“Yes, it is a little setback for employees but this return is not bad—8.65% is after taxes. If we extrapolate it to before taxes, it will be around 12%," Wadhwa said.

Financial planners maintain that EPF should not be discontinued. “I do not suggest anyone to opt out of EPF," said Prakash Praharaj, founder, Maxsecure Financial Planners, and a registered investment adviser with the Securities Exchange Board of India (Sebi). “A return of 8.65% is also good. Look at the 10-year g-sec yields. A rate of 8.65% means a tax adjusted return of 11-12%," he said.

If interest rates go down further, savings may be affected. Ashish Shanker, head-investment advisory, Motilal Oswal Private Wealth Management, said that from here on, small investors and salaried workers should brace for the impact from reduction in interest rates on retirement savings.

Every month, a salaried individual contributes 12% of her basic salary into the EPF account and the employer matches this. A part of the employer’s contribution goes to the Employees’ Pension Scheme (EPS).

Contributions made to EPF compound at a rate declared every year. For salaries above Rs15,000 a month, EPF is voluntary. You can opt out in the beginning, but not midway or when transferring an account. In financial year (FY) 2013-14 and FY15, the interest rate was 8.75%, and 8.5% in FY13. It had given returns of 9.5% in FY11.

Even after the reduction, EPF continues to be an important vehicle in the debt space for long-term goals such as retirement.

But such reductions may impact voluntary contributions by employees.

You should remember that, given the current interest rate climate, this is the best tax-free and assured return available.