It is hard to find a salaried person who would not be aware about the monthly deductions being made from their payslips towards the Provident Fund (PF) contributions. Though being made every month and month on month, not all people are aware of what are the benefits of PF and the associated regulations. The purpose of this article is to appraise th
em of these minor but important aspects of PF and how to make the best out of this investment instrument.
Provident Fund is a long term or rather the one of the best and safest retirement solutions available for a salaried employee in India. Generally an employer having more than 20 employees is required by law to operate Provident Fund scheme. The employer pays 12% of the monthly emoluments of an employee as an employer contribution into a provident fund account opened with Employees Provident Fund (EPF) India. Similarly, the employee is also required to pay an equal 12% of their monthly pay into the EPF account
. This amount is deducted from the salary before crediting it into the employee’s bank account. You can consider it operationally similar to the monthly TDS deducted by the employer. Employees also have an option to get additional funds deducted from their salary and invested into their PF account by providing their employer a written request.
Where is the fund invested ?
When we wrote the word ‘Safest’ in the start of the blog, then we really meant that PF is one THE SAFEST investment channels available for a salaried employee. Provident fund accounts are provided a fixed interest at a rate fixed by the government on an annual basis. Due to the political sensitivity, this rate is generally fixed higher than the prevailing market interest rate. Interest is credited to the account on a monthly basis. You may feel surprised, but the interest rate in 1999 used to be as high as 12%. In early 2000 this rate was around 10.5% and it got reduced gradually to around 8.5% by 2009. Currently since 2011 this rate is fixed at 9.5%. A tax free 9.5% rate equates to around 13.5% taxable interest income.
How much PF deducted ?
Broadly, an employer has to pay 12% of an employee’s (Basic plus Dearness Allowance) on a monthly basis as PF contribution. Further an employee also has to contribute the same amount on a monthly basis. For example, if an employees monthly salary is Basic Rs. 15,000 and Dearness allowance Rs. 5000 totalling to Rs. 20,000 per month (Gross salary). The employer shall pay 12% of Basic+DA or 12% of Rs. 20,000 (Rs. 2400) as their monthly contribution to the PF account of the respective employee. Similarly, the employee shall also contribute an equal amount, i.e. Rs. 2,400 towards their PF contribution. Employee’s PF contribution is deducted from the gross salary before providing the net cash salary to the employee. You invest Rs. 2,400 and your employer would be investing Rs. 2,400 as well or in other words, your Rs. 2,400 investment toward PF becomes Rs. 4,800 on day 0. Doesn’t it sound too good to be true ? Doesn’t it sound a bit harsh towards the employee – possibly not..
Cost to Company or CTC
Most private sector companies have introduced a term ‘CTC’ or Cost to Company. In other words, the companies while hiring an employee declare the total package as CTC instead of gross package. Employer’s contribution towards PF is added to the gross salary and reflected as CTC. For example, if your gross yearly basic salary is Rs. 500,000, the employer shall contribute Rs. 60,000 per year towards your PF. The company shall publish you total yearly emoluments as Rs. 5,60,000 as CTC as it is the total cost which the company is bearing towards the employment.
There is not one but multiple tax aspects associated with PF. Some of these are mentioned below :
1. The most important tax benefit of PF is that both the employer contribution, your PF contribution and associated interest on PF balances is tax free at the time of withdrawing of PF. However this would be tax free only if the withdrawal from PF is on the following grounds :
- On the death of employee.
- On permanent disability of employee.
- In case the business of the employer is disrupted.
- On the completion of 5 years service of continuous service of the employee. As this condition is most common, it requires a bit elaboration. 5 years of continuous service does not mean that it should be from one employer only. For example, if you have worked for 3 years in Company A and left the employment to join Company B and worked there for another 2 years. Both of these services would be clubbed together to identify if you have been in service for 5 years. If you left Company A & didn’t work for some time and then joined Company B, then your service in Company A would not be clubbed for the purpose of computing 5 years of continuous service.
2. Even if you are eligible to be taxed (as you did not meet the conditions specified in point 1 above, only Employer’s contribution to your PF and interest accrued on your PF balances (both Employer and Employee contribution) shall be taxed. In other words, Employee’s contribution shall not be taxed.
3. As per the current laws, your (employee) contribution towards PF is eligible for tax rebate under section 80C of Income tax act upto Rs. 100,000 per year. However, this may change in the coming new Direct Tax Code (Income Tax Act).
Owing to the above benefits, many employees often go ahead with contributing more than the minimum statutory requirement of 12% of the Basic+DA amount. The maximum amount which an employee can contribute is upto 100% of the Basic part of the salary. The extra contribution, generally called as Voluntary contribution is also eligible for the same interest rate earned by the PF account and is also tax free. You need to contact the HR department of your company to request for increasing your minimum contribution towards PF by filling up a form. Some companies put in restrictions that an employees can increase or reduce their voluntary contributions only during specific times in year such as yearly, half yearly or quarterly. You must be aware that while this extra voluntary contribution is one of the best investment options, it would result in reducing your take home net cash salary.
Dormant PF account
This is the most common ways by which even after contributing to your PF account you can loose upon a material amount of interest. If you do not contribute to your PF account for more than 3 years, your PF account becomes inactive and will not be provided interest.This rule has been implemented from 1 April 2011. You may be wondering that if you are working as an employee in India, then it is mandatory for you to contribute to your PF. Hence till you are working, you would be contributing to your PF and hence your PF account should not become dormant. However, this is valid only for your current PF account – the one into which your current employer & you are contributing into. If you have other PF account from previous employers, you will not be contributing to those PF accounts. Unless you transfer those PF accounts into your current PF account, all except your current PF account will become dormant after 36 months from the date of last contribution. Hence it is VERY IMPORTANT THAT YOU TRANSFER YOUR PREVIOUS PF BALANCES TO YOUR CURRENT PF ACCOUNT. This would prevent your previous PF accounts from becoming inactive as well make them administratively efficient to be managed.
Transfer of PF Balances
Not every person is in the same job upto his / her retirement. It may still be true for public / goverment sector jobs, but in other cases people keep on changing jobs in private sector after every few years. When you join a new employer, they open a new PF account and deposit your contributions to the new account. However, you may be surprised that not many people think about consolidating their PF balances and their PF balances may be scattered across multiple PF accounts. I even know a couple of people who have over 20 PF accounts and they have even lost track of their exact PF details. So what is the best solution out here ? Once you leave your job, you should transfer the PF balances from your previous employer to your new employer’s PF account. This would ensure that your PF balances are consolidated in one account. Also as mentioned in the earlier paragraph, it would prevent your previous PF account from getting into an inactive state. It is simply like transferring funds from your one bank account to another and closing previous bank accounts. This kind of transfer generally takes around 30 days and can be initiated after 2 months of leaving your previous employer. Form 13 is generally used to transfer PF balances (Form 13 – PF Transfer).
Should You Encash Your PF Balances ?
This is a very tempting question which may end up releasing your past PF contributions to your bank account ! In many cases this amount can be in several lakhs and hence it becomes even more tempting to milk your PF account to fund your current liabilities / investment decisions. How often I have come across people who have encashed their entire PF balances to fund their car purchase, paying the deposit for their property, children education, foreign holidays or furnishing their houses. But have you thought about how much danger you are putting your future into by encashing your PF balances. Some points which are worth a consideration are:
- PF balances grow based upon the power of compounding. We have explained the principle of compounding on a seperate blog Fixed Deposits – How to Benefit the Most Out of them. If you encash your PF balances in earlier stages, you will not be able to take advantage of compounding and hence would loose upon the opportunity to allow your money to grow.
- You might end up buying a house to live in using your PF balances – but did you ever realise that the house which you live in is a biggest dead asset. Sorry if it sounds harsh – but though that house would provide you shelter, but it won’t provide you a monthly income – something which you would really need post retirement.
- One of the comparisons which may assist you in deciding if you should really encash your PF is the Gold / Jewellery asset which you may have for wife. Would you sell your family gold / jewellery to acquire the investment or expend the funds for which you are currently thinking about encashing your PF balance. Fortunately / unfortunately Indian families consider wife’s jewellery as a central bank which is lender of the last resort. A family’s jewellery is tapped only if there is nothing remaining in the family’s finances to cater to the emergency spending requirement. If you still think that the requirement of the situation is so grave that you must tap your PF balances, then go ahead.
- Encashing your PF balance can have immense ramifications on your financial situations, both from taxation and investment portfolio perspective. Hence you must consult your financial advisor before taking this decision. If you don’t have one, please feel free to contact us. Our contact details are mentioned on our Contact Us page on www.banyanfa.com.
How to Encash
If you want to withdrawn your PF balance, then you need to fill Form 19 and submit with EPF authorities. Updated form can be downloaded from http://www.epfindia.com/downloads_forms.htm . Encashment request is taken after 2 months from the date of leaving the service. The form has specific section where the applicant has to mention the bank account where the funds are to be credited. Once the form is processed by EPF, the proceeds are directly credited into the bank account of the appliant.
Employee’s Pension Scheme (EPS)
Another component of PF is EPS or Employee’s Pension Scheme, governed by Employee’s Pension Scheme -1995. The benefits of EPS are as follows:
- Provide pension for life to the scheme member after retirement.
- If the member dies, pension is provided to the following family members:
- If the member was married, pension is provided to the widow / widower for life or till remarriage;
- Additional pension provided for upto two children/orphan upto 25 years of age along with pension provided to widow/widower;
- Children/orphan with total and permanent disability shall be entitled to payment of children pension or orphan pension as the case may be irrespective of age and number of children in the family;
- In case the member is not married, pension is paid to the nominee; and
- If there is no nominee and the member does not have any family, pension is paid to dependent father/mother.
Eligibility of Pension under EPS
A member is eligible for pension upon completion of 10 years of service and attaining 58 years of age. If the member choses to retire between 50 to 58 years of age, the pension shall be provided by deducting 3% for each year less than 58 years. This condition does not apply if the member dies before 58 years of age.
Do I have to pay anything to get Pension under EPS ?
Good news is that you don’t need to contribute any more than what is being deducted for PF i.e. 12% of your salary. EPS amount is deducted from Employer’s share of PF at the rate of 8.33% of the Salary. For the purpose of computing the EPS contribution, maximum salary is maintained at actual salary or Rs. 6,500 per month which ever is lower. For example, if your salary is Rs. 10,000 per month – the PF being paid by the employer shall be 12% of Rs. 10,000 = Rs. 1200 per month. Out of Rs. 1200, EPS amount shall be diverted from Employer’s contribution towards EPS. To calculate the EPS amount, the monthly salary shall be considered at Rs. 6,500 (as Rs. 10,000 is greater than Rs. 6500). EPS amount in this case shall be Rs. 541 (8.33% of Rs. 6500). This amount shall be deducted from your Employer’s contribution of Rs. 1200 and sent to EPS. To clarify, nothing is diverted from Employee’s share towards EPS.
If you are looking out for information on PPF, you can read our article Public Provident Fund
The article is written by Banyan Financial Advisors. You can contact us on www.banyanfa.com. An alternative page on PF can be referred to at www.banyanfa.com/banyanfa/saving_investment/pension_schemes/emp_fund.html