EPF relief to increase take-home salary, but you may end up paying higher taxes

In order to provide more liquidity in the hands of employees and ease the cash crunch that employers may be facing, the government on Wednesday reduced the monthly provident fund contribution for both employee and employer from 12% each to 10% each for the next three months.

Both employees and employers together contribute 24% of the basic salary plus dearness allowance on a monthly basis towards the employee’s provident fund (EPF). Now, they will be contributing 20% during this period.

If your basic salary plus dearness allowance is ₹50,000 per month, your PF contribution is equal to ₹6,000 ( ₹50,000*12%) and with a similar contribution by the employer, your monthly PF contribution is ₹12,000. Now, the reduced contribution will be ₹10,000 ( ₹50,000*20%). Your income will increase by ₹1,000 per month that is 2% of your basic salary plus dearness allowance. As your employer will be contributing less, this will bring down your cost to company (CTC) by 2% for these months.

“Yesterday's announcement helps EPF employers conserve 2% of cost to the company (CTC) and aids employees by increasing their take-home pay by 2%. We needed that quantum to be at least 6% (given it is non-subsidy in nature),” said Rituparna Chakraborty, co-founder, TeamLease Services.

Tax implications

The lower EPF contribution and increase in in-hand pay will have tax implications. “The tax will be applicable as per the slab since this amount is treated as income,” said Mrin Agarwal, founder director, Finsafe India Pvt. Ltd.

For example, if your income increases by ₹1,000 and if you fall in the highest tax bracket, your take-home will only go up by ₹700 as rest will be deducted as tax.

Employees also avail of tax deductions under section 80C against the contribution towards EPF. As the contribution will be lower, they will have to save more via other investment options to use Section 80C or else will have to pay higher taxes.

If your three months PF contribution was ₹18,000 and you were in the highest tax bracket, you were able to save ₹5,400 on taxes by claiming a deduction of ₹18,000. Now as your contribution will go down to ₹15,000, you will be able to claim a lesser deduction and tax savings will also go down to ₹4,500. You will have to save an additional ₹3,000 under other eligible investments under Section 80C if you were using PF contribution to exhaust your Section 80C deduction limit.

“With the 10% EPF contribution, employees will have somewhat better cash flow, eventually as the year progresses individuals will have to assess and make tax investments,” said Shalini Dhawan, co-founder Plan Ahead Wealth Advisors.

“This EPF contribution will be lower for these three months, which can be caught up by other 80C investments. ELSS or life insurance coverage premiums or even voluntary provident fund contribution is eligible for Section 80C benefits,” she added.

Lower retirement corpus

Provident fund is one of the most popular retirement savings products where people get the benefit of compounding to grow their retirement corpus. Therefore, lower PF contribution will also mean that your retirement savings kitty will be impacted.

“Somebody, who is seeing potential job loss or significant salary cut, will get some help through lower PF contribution, but those who are able to manage the situation and are not impacted by the covid-19 crisis will actually lose on the retirement corpus,” said Anil Rego, CEO and founder, Right Horizons.

If you along with your employer were contributing ₹12,000 per month towards the PF, the contribution will reduce by ₹2,000 per month for the three months. So, if somebody will be retiring after 25 years, then this will reduce the retirement corpus by around ₹46,000 supposing PF grows at a rate of interest of 8.55% per annum throughout this period.

As contributing a lower amount towards PF is not optional and everyone will have to contribute a lesser amount, those who are able to manage their cash flows should ideally invest the amount received in hand due to lower PF contribution.

“If someone is able to manage the cash flow, it may make sense to invest the amount received towards investments such as a voluntary provident fund,” said Rego.