New Delhi: If the government’s Social Security Code Bill, 2019, gets nod from the two House of Parliament, you will soon have the option to reduce your provident fund (PF) contribution — currently at 12% of basic salary — and increase your take-home.
The rationale behind the move
The government’s rationale behind reducing the employee PF contribution is to boost consumption with a higher take-home salary. The falling consumption has been dragging growth down. While the move may or may not be sufficient to boost consumption at a time when the GDP has gone down to a six-year low, it could certainly hit your retirement savings.
What you stand to lose
Deepali Sen, Founder, Srujan Financial Advisors said, “Saving less and spending more ideology has a high probability of being counter-productive and may leave you with less than needed corpus at a time when your prime earning years are behind you. Reducing the quantum of PF contribution could compromise on the retirement savings of many. In India, most people lack financial literacy. They may end up investing in instruments they do not understand and may mark-up their returns expectations to an aspirational level, which may not happen, thus leaving them with a less than expected corpus."
With EPF contributions, someone is unable to save much and make investments, ends up with at least some money in hand at the time of retirement.
“The move will allow people to choose from other investment avenues which give better returns. However, it needs financial literacy and discipline which most people do not have. If one reduces the quantum of PF contribution and spends it instead of investing it, there could be a huge dent in his retirement corpus," says Vikas Gupta, chief executive officer and chief investment strategist at Omniscience Capital.
If you think reducing your EPF contribution is a good idea, here’s what you may miss out on:
Guaranteed risk-free returns
EPF is government-backed retirement savings scheme that offers a guaranteed rate of return. The rate of interest (ROI) on PF is reviewed every year and for FY20, it is 8.65%
The compounding effect
Compounding is the key to wealth creation, as generating returns on returns becomes a sequential process as long as you stay invested in the financial instrument. Even a small reduction in the quantum of investments can lead to a significant fall in your returns.
“If you start investing in ₹1,500 a month at the age of 26 and increase the investment amount by 5% every year, at a rate of 8.65% which EPF is currently offering, you will accumulate a corpus of ₹56,88,524 by the time you retire at 60. However, if you start with just ₹500 less, your corpus will be reduced to ₹37,92,349," Sen explains.
Also, interest rates in EPF have been falling for last many quarters. Therefore, an 8.65% return may be aspirational after a few quarters.
Income tax benefit
EPF contributions are eligible for income tax deduction under section 80C. The maximum amount of deduction that can be claimed this section is ₹1.5 lakh. Reducing the percentage of your EPF contribution may result in higher tax payout if you do not have other tax-efficient investments.
While it is not advisable to make premature withdrawals from your retirement savings, the EPFO subscribers can make partial withdrawals after 5-10 years of service for specific needs including medical treatment, home loan repayment and unemployment, which may come handy during unforeseen financial crisis.