Why VPF, NPS should be in your retirement portfolio

Voluntary provident fund (VPF) and national pension system (NPS) are two schemes that work well for such employees and other conservative investors. That’s what Venumadhav (51), a resident of Bengaluru who is employed at a startup there, does. He realized somewhat late in his life that he needed to perk up his retirement portfolio. He was in his late 40s and was looking for safer instruments to accumulate his retirement corpus “I could have opened a public provident fund (PPF) but the lock-in period of 15 years dissuaded me. I chose VPF because no other product in the fixed income category would have given me more than 8% returns," says Venumadhav.

VPF is a way to increase employee provident fund investment, which is usually 12% of the basic salary. Here is more on how VPF and NPS work.

Interest rate

Most investors are hugely concerned about the returns that a financial product offers. But they need not worry where it concerns either VPF or EPF: the interest rate was a healthy 8.15% for FY23. To be sure, it is reviewed every year and is mostly on the higher side compared to other government savings schemes such as PPF, national savings certificate and kisan vikas patra.

NPS returns are linked to the market. There are different NPS schemes based on predominant exposure in equities, corporate bonds, or government securities. “EPF/VPF and NPS both invest in equities and debt but the former is not unitised. It means the rates largely remain the same, while NPS returns are market-linked. NPS equity schemes could easily give more returns than EPF/VPF.. Returns in conservative NPS schemes would be closer to what EPF or VPF offers," says Amit Gopal, business leader-India investments at Mercer, a retirement consulting firm.

Maximum investment limit

Most companies deduct 12% of the basic salary of employees to invest in the EPF accounts. Note that EPF and VPF contribution together can go as high as 100% of your basic salary. For instance, if your employer is already investing 12% of your basic salary in EPF, you can add up to 88% of your basic salary in VPF, at the cost of a lower take-home pay. For this though, you need to ask your company to open a VPF account at the start of the financial year.

If the contribution in EPF/VPF is more than ₹2.5 lakh in a year, the interest income on the additional amount gets taxable. For example, if your basic pay is ₹4 lakh per annum and you contribute 100% of your basic pay in EPF/VPF, two accounts will be created. One is for contributions up to ₹2.5 lakh and the other for additional contribution of ₹1.5 lakh. The withdrawal from the first account will be tax free on maturity and the interest earned in the second account will be taxable as per your slab rate. There is no upper limit to invest in NPS by an individual or an employer.

Tax benefit

The amount you invest in EPF/VPF is eligible for tax deduction under section 80-C of the Income Tax Act, 1961. The maximum deduction allowed is ₹1.5 lakh if you don’t opt for any other 80-C deductions such as equity-linked savings scheme, life insurance premium and PPF, etc.

NPS is also a part of section 80-C deductions. If you have exhausted your 80-C limit of ₹1.5 lakh by other options, you can claim tax deduction up to ₹50,000 under Section 80CCD(1B) by investing in NPS.

Moreover, if your employer also contributes to NPS as part of your salary, you can claim tax deduction under section 80CCD (2). This tax benefit is allowed in the new tax regime also. However, the tax deduction cannot exceed 14% of the salary in the case of central government employees and 10% in the case of a private employee.

Notably, the employer’s contribution to EPS, NPS and superannuation exceeding ₹7.5 lakh per year is taxable as perquisites in the hands of the employee under the head ‘income from salary’.

Withdrawals

Premature withdrawals from EPF and VPF are barred while you are employed. However, partial withdrawal for certain needs such as buying a house, marriage, post-matriculation education of children and natural calamity is allowed.

You can withdraw the entire corpus on attaining 55 years of age or two months after you leave your job. Some people withdraw the full amount when they switch jobs. It is advisable to transfer the EPF/VPF corpus to the new employer’s account instead of withdrawing it. Note that 90% of total PF balance can be withdrawn a year before retirement.

The NPS account matures at the age of 60 but can be extended until the age of 75 years and 60% of the maturity corpus can be withdrawn as lump sum. Subscribers will have to use 40% of accumulated corpus to purchase an annuity that would provide a regular monthly pension. People can opt for 100% lump sum withdrawal if the accumulated corpus is less than ₹5 lakh.

Partial withdrawals of up to 25% of your contributions can be made from the NPS after three years of opening the account but this is allowed only for specific purposes like home buying, children’s education, or to meet expenses pertaining to treatment of serious illnesses. Only three such withdrawals are allowed during the entire tenure of the subscription. Premature withdrawals in NPS are not allowed from the employer contributions.

Premature exit

Premature or early exits are allowed in NPS on completion of the fifth year but lump sum withdrawal is limited to a maximum of 20% of the total amount. The remaining 80% will go into annuities for monthly pension.

The VPF/EPF account is anchored to your employment. If you leave your job, fresh contributions to EPF/VPF will stop, but the account will keep earning interest . “The PF is treated as ‘inoperative’ in cases where no claim application for withdrawal is made within a period of 36 months from the date such amount becomes payable: a) employee retiring from service after attaining 55 years of age ;b) employees migrating abroad permanently ;c) death of employee," says Anurag Jain, co-founder and partner, ByTheBook Consulting LLP.

Tax benefits

Typically, withdrawals from EPF/VPF remain tax free after five years of continuous employment, but the tax treatment changes if you leave your job. “If you withdraw immediately after leaving the job (after rendering five years of continuous service), the amount will be tax free. However, if you withdraw after 1- 2 years of leaving the job, while the PF accumulations up to the date of leaving will be tax free, interest earned from the date of leaving to the date of withdrawal of the amount will be taxable," says Jain.

It is to be noted that VPF does not have any separate lock-in for withdrawals or tax treatment. “It is clubbed with the EPF lock-in," adds Jain.

At retirement, tax-free maturity corpus is allowed from the account where contributions up to ₹2.5 lakh per annum have been accumulated. The interest earned on additional contributions (in the other account) will get taxed as per your slab rate.

In NPS, 60% of the corpus can be withdrawn tax-free after retirement. The remaining 40% will be used to buy annuities. The monthly pension via annuities will be taxable.

VPF versus NPS

Which one is better? Both have their flaws and benefits. EPF/VPF is more flexible and liquid during the investment phase. However, after retirement, if you wish to extend the maturity period to keep earning interest, you’ll have to keep working full-time in case of EPF and VPF. In NPS, even if you are not associated with an employer, you can still defer the maturity period of lump sum withdrawal or annuities or both up to 75 years of age. Given the increasing life expectancy of people, it is a good option.

“As for risk and asset allocation, both are at a par because both products invest in equity and debt. Conservative investors should choose VPF over NPS because the interest payment in EPF/VPF is aligned with Indian thought process where people seek safety over higher returns for the retirement goal," says Gopal.

Young employees should choose NPS because they may leave their full-time job to start a new venture and explore their passions.

“NPS is better for people who may go for a career break. They can continue adding money in NPS even after leaving the job, while EPF/VPF investment is linked to employment," says Gopal.