Here, we discuss whether it makes sense to increase your provident fund contribution
Or, does a Voluntary Provident Fund or VPF contribution make sense?
You can increase your provident fund contribution beyond the mandatory 12% of Basic and DA
The mandatory 12% needs to be matched by an equal contribution by the employer
You can increase your contribution to 100% of Basic + DA
Employer will typically not increase the contribution above the mandatory amount
You can do this by opening a VPF account through your employer
You commit on your regular enhanced PF contribution
There is a 5-year lock in for the money after you start a VPF
Premature exit before 5 years is taxable and withdrawals become tax-free after 5 years
VPF contributions are low risk since PF investments are in low risk debt investments
There is a small exposure to equities
Employees’ Provident Fund (EPF) also has a typically high interest rate
Interest rate is announced annually with 8.1% being announced for 2021-22
EPF is run by Employees’ Provident Fund Organisation (EPFO)
EPF interest rate of 8.1% is much higher than PPF, another government scheme, offering 7.1% p.a
You get Section 80C benefit for contribution with interest and maturity amount being tax-free
This makes EPF returns effectively much higher
Enhanced deduction from payroll without having to bother where to invest is also suggested as an advantage
We will argue that enhancing EPF contribution through VPF is beneficial to only a few
VPF will not make sense for most, especially the young
EPF interest rate declined in the past and stayed at the lower level for long
After 9.5% in 2009-10, it has never crossed 9%
It has been in the 8.5% region in the recent past
Before increasing your PF contribution, you need to explore possible alternatives
If someone invested in equities through index funds would have got 14-15% returns
During the period, annual inflation was 6%
Provident Fund returns adjusted for inflation was about 2.5%
Thus, alternatives perform better compared to higher PF contribution
For healthy retirement savings, you need a 4% return after accounting for inflation
Since EPF is constantly delivering below this level, you can’t rely on it in a major way
For tax deduction, you can rely on National Pension Scheme (NPS)
Leading equity funds in NPS have given 14-17% p.a. In the last 5 years
You can opt for Aggressive Lifecycle Fund starting with 75% equity and declining after age 35
For lower risk, opt for Moderate Lifecycle Fund which starts at 50% equity, declining after age 35
Conservative Lifecycle Fund starts at 25% equity, declining progressively after age 35
You are likely to get a much higher return through NPS rather than VPF
You get an extra Rs 50,000 tax deduction under Section 80CCD(1B)
This is over and above Rs 1.5 lakh annual tax deduction under Section 80C
If you invest only in NPS, you first get annual tax deduction under Section 80CCD(1)
You can look for alternatives other than tax saving investments
They include retirement funds without tax savings and regular investments
NPS also gives 60% tax free lump sum on retirement with 40% converted into regular income that’s taxable
A larger retirement accumulation helps you handle tax impact better
Items like home loan principal repayment and children’s tuition expenses vie for attention for Section 80C deductions
Interest earnings on annual PF contributions exceeding Rs 2.5 lakh is taxable
Interest on monthly contributions exceeding Rs 20,833 is taxable
Thus, the scope for increasing PF contribution is limited
Increasing VPF contribution can work for you if it is below Rs 2.5 lakh p.a
Increasing PF contribution through VPF makes sense when you are nearing retirement
You are already reducing the risk in various retirement investments
This will help in bringing in a little more predictability in the returns