EPF still top scorer despite cut in interest rate to 40-year low - 5 Reasons

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EPF Interest Rate 2021-22, EPF Interest Rate Cut: The Employees’ Provident Fund Organisation (EPFO), responsible for regulation and management of provident funds in the country, has cut the interest rate on EPF to a 40-year-low of 8.1 per cent for the financial year 2021-22, causing more pain to the salaried class at a time when inflation is at an 8-year-high. The interest rate for the financial year 2020-21 was 8.5 per cent.

Although the announcement was made on May 3 after ratification by the Central government, Finance Minister Nirmala Sitharaman had in March strongly defended the EPFO decision to cut the interest rate. She had said in the Rajya Sabha that the rate is dictated by today’s realities where the interest rate on other small saving instruments was even lower. To make her case, Sitharaman referred to returns on government-backed small saving schemes that offer safe and assured returns.

Sitharaman was absolutely right. A quick comparison between the interest rate on the government's small savings schemes and EPF shows that the latter is a lucrative destination to park funds for a fixed return.

EPF vs PPF, SCSS

Schemes like Public Provident Fund (PPF), Sukanya Samriddhi, Senior Citizen Savings Scheme (SCSS), State Bank of India's (SBI) ten-year fixed deposit, Post Office saving schemes like Time Deposit Scheme (akin to bank FDs), Monthly Income Scheme, savings certificates like the National Savings Certificate and the Kisan Vikas Patra are time-tested and considered to be safe mode of investments. These schemes don’t offer quick returns, but in return, they are much safer (because of the government backing) than the schemes linked to the equity market.

It is worth mentioning here that the yield on 10-year government bond is currently below 7%.

EPF Historical Returns

In FY 1952-53, EPF interest rate was 3% which gradually increased to 8% in 1977-78 and then 12% in 1991-92.

It is important to mention here that EPF contribution too enhanced gradually since 1952-53 when 1 aana per Rupee was payable on total basic wages, DA and food concession by both -- employee and employer.

EPF Remains Best Bet - 5 Reasons

1. Mandatory Clause

EPF contribution is mandatory for a salaried person. As per the rule, 12 per cent of the basic salary and dearness allowance is credited to the EPF account every month. You don't have a choice here to stop the contribution. You save regularly irrespective of your will. This mandatory clause allows EPF to score over other schemes.

It is a win-win deal for those making additional investment (more than 12%) in voluntary provident fund (VPF).

2. Contribution

Contributions towards EPF accounts are done by the employee and the employer as well. The employer deposits the amount into the EPF account of employees directly on a monthly basis. While the employee contributes 12% of basic salary and dearness allowance, the employer too contributes a similar portion of the employees' salary (8.33% towards the Pension Scheme and 3.67% towards the EPF). Accordingly, the total contribution in an EPF account becomes 24%.

3. Compounding Interest

EPF interest is yearly compounding. To make it simple, you earn interest on interest received on contributions. Again, this makes EPF a lucrative destination for parking funds to get a handsome return.

Though the interest is computed every month, it is credited at the end of the financial year.

4. Tax Benefits

EPF offers tax benefits too! It is considered one of the most tax-efficient tools.

It enjoys the status of Exempt, Exempt, Exempt (EEE). Contributions here are deductible from the salary of an employee and no tax is applicable on the amount. The contribution can be claimed under Section 80C of the Income Tax Act. Also, the earned interest or the maturity amount is absolutely tax free.

Starting 2021-22, the government introduced a clause wherein interest earned on EPF contributions of over Rs 2.5 lakh is taxable.

Other government-backed small saving schemes also offer tax benefits similar to EPF. But schemes like SCSS and FDs are taxable.

5. Retirement

EPF is a traditional tool for saving for retirement. In fact, it is a trusted retirement planning avenue. The higher you contribute, the higher you generate. Besides, you save tax at three stages -- contribution, interest accumulation and withdrawal.

The entire corpus can be withdrawn after retirement (withdrawn before retirement is allowed in certain conditions).

Where Is EPF Contribution Invested?

EPF is primarily a debt product. The funds are invested majorly in debt products like government securities. In 2015, the EPFO was allowed to start investing in equities, but with a limit. The statutory body was initially permitted only 5% exposure in equities. The limit was increased to 15% in 2017.

READ MORE: Govt approves 8.1% EPF interest rate for 2021-22, lowest in 40 years