Young People always ask, “When should we start planning for retirement?” This question has only one and a very simple answer, “From the day, you start earning.” They are further troubled by the taxes on Income if they start getting good salaries.
Then the second inevitable question, “How do we start”?
Today job market is highly competitive. It is hard for a common man to get a job with a decent salary. Once people find a job, they want to spend money to fulfill their needs and desires but their salary is limited.
This leads to over spending and sometimes they get stuck into a debt trap. It is very easy to get credit cards and then get into revolving credit etc.
Therefore, some of the employers caution the new employees and counsel them on their spending habits. We can study some of the ideas here.
There are various instruments, which can be used depending upon the risk profile of an individual to accumulate funds for retirement. Sooner the people start, quicker they reach their goal. Mutual Funds, Equity, ULIPs, NPS, Post office schemes, PPF, EPF, VPF etc. are various instruments of which Mutual Funds and equity are little risky. Others being interest bearing instruments are safer in nature.
Let us compare EPF, VPF and PPF as these are rather simple ways of savings wherein risk is non-existent due to Govt. guarantees and importantly the returns thereon are also tax free till now.
Employee Provident Fund (EPF) – It is a provident fund created with a purpose to provide financial security and stability to the employee. Under this plan employees save some part of their salary every month so that they can use it later at the time of retirement. It is mandatory for salaried people working in organizations registered under the Employees’ Provident fund Organization (EPFO) to contribute 12% of their Basic + Dearness Allowance. The employee alone doesn’t contribute 12% of his salary, the employer as well contributes the same amount. Participation in EPF is mandatory for employers who have more than 20 workers. Also, the amount saved earns interest and the contribution is also eligible for tax deduction. The most attractive feature about EPF is that it is risk free and could be chosen as an investment tool to be used after retirement.
This is a compulsory part. The employee does not have option except low paid employees to whom last year’s budget allowed option of not participating therein.
It is very strongly recommended that all the employees should participate and save some part of the earnings, which accumulate and earn interest and available in case of emergencies or when a lump sum amount is required, say for purchase of house etc.
Voluntary Provident Fund (VPF) – As the name suggests, the employee availing EPF can voluntarily contribute any percentage of his salary to the Provident fund account. The additional contribution is over and above 12% that has been mandated by the government. The employer however is not obligated to contribute any amount towards VPF. An employee can contribute 100% of his basic salary and DA. Interest offered would be the same as EPF and this amount would be credited to EPF account only as there is no separate account for VPF. As stated, the employer need not contribute any additional amount.
Personal Provident Fund (PPF) – It is a government-guaranteed fixed income security scheme with the special objective of providing financial security to the unorganized sector/self-employed persons. Employed person also can open PPF account. The accounts are generally opened in Post Offices or any nationalized Bank of SBI. Anyone can contribute to PPF account and get risk free and assured returns. All the balance that accumulates over time is exempt from income tax. The scheme is for 15 years but partial withdrawal is possible after initial six years. Even loan can be obtained in this scheme.
As stated earlier, the interest earned on all these schemes are tax exempt and hence not to be included in the income for calculation of Income Tax.
They fall in the category called EEE, i.e. investment made under Exempt, Exempt, Exempt (EEE). It is one of the best tax saving instrument. First E implies an exemption on the amount invested on the product. Second E implies an exemption on interest or any income earned under the product. Third implies there is an exemption on the maturity proceeds from the investment.
Having understood what PPF, EPF and VPF are, we need to examine which is the one that is more attractive amongst all. We can compare these products on factors like eligibility, contribution, tax benefits, returns, withdrawal facility etc. This would help us understand the pros and cons of each of them.
Besides EPF, both in VPF and PPF the contribution is voluntary. Only salaried individuals can sign up for VPF whereas PPF is for both salaried and non-salaried individuals. An employee who wants to increase his retirement savings can tell the employer to deduct a certain percentage above the necessary 12% of basic pay and dearness allowance that goes towards EPF account. An employee can even contribute 100% of basic pay and dearness allowance towards VPF account (part of EPF). For VPF, the employer is not bound to contribute any amount. Still there are certain employers who contribute more than the statutory requirements.
Talking about maximum subscription in each of the schemes, PPF account has an upper limit of Rs.1.50 lakh per year, whereas there is no such limit in case of VPF contribution. Also, one can contribute either a lump sum amount in the PPF account or distribute the investment amount into periodic payments.
Interest on PPF is 8.70% for the year 2014-15. However, the rate is expected to go down in the coming budget. Interest rate on VPF is the same as offered on EPF account. Recently for the financial year, 2015-2016, EPF has fixed the rate at 8.80%.
People from all walks of life including salaried employees are eligible to open a PPF account either at bank or Post Office and earn the same assured high returns. While VPF and EPF scheme can only be availed by salaried individuals, VPF subscribers can contribute any amount over the necessary 12% which will be contributed in EPF account. As stated all the interest earned is exempt in Income Tax without any upper limit.
EPF/ VPF: Amount is payable at the time of retirement or resignation. Or, it can also be transferred from one employer to another if one switches jobs. On death, the accumulated balance is paid to the legal heir. With automation taking place in Regional Provident Offices, things such as withdrawal are expected to become much easier in near future.
PPF: Amount can be withdrawn only on maturity, that is, after 15 years of opening the account. On death, the accumulated balance is paid to the legal heir. The account can further be extended by a term of 5 years at a time, after the initial 15 years.
In case of the PPF account that is to be maintained for a minimum of 15 years, only partial withdrawal is allowed subject to some terms and conditions The account can further be extended for another 5 years. However, the money from a EPF/VPF account can be fully and conveniently withdrawn.
With automation taking place in Provident Fund offices, the amounts can be withdrawn online after August, 2016 as per the latest publications by the PF authorities.
Further, if withdrawal from the EPF/ VPF account happens prior to completing 5 years of service with the employer, then that amount would be taxed.
From the above comparison we can observe that EPF and VPF score over PPF in terms of Return on investment, Employer Contribution, Liquidity. But we also know that EPF and VPF cannot be subscribed to by self-employed and employees in un-organized sector, therefore PPF is a better choice. For the employees having higher salaries/ double income, who are risk averse, should seriously think of investing in VPF. It certainly scores over bank FDs which pays you only 8.5% pa, on which tax has to be paid. If tax is considered @ 30% (For income Above Rs. 10 Lacs) we get only 5.95% (i.e., 8.5% Less Tax @30% i.e., 2.55% = 5.95% excluding Cess)