Budget 2021 has proposed that employee contributions made to the Employees’ Provident Fund (EPF) or exempted PF trusts above ₹2.5 lakh would trigger taxability on the interest accrued on the amount above the threshold limit. In this scenario, does it make sense to go for an alternative retirement tool such as the National Pension System (NPS)?
NPS has scored in terms of returns over EPF in the past few years, but it’s returns are not as risk-free as EPF’s, but they are competitive in terms of tax efficiency now. They both get tax deduction at the contribution stage (EPF up to ₹1.5 lakh and NPS up to ₹2 lakh); interest accumulation is tax-free for both; but there is a minor difference at the withdrawal stage. While the entire EPF corpus is tax-free until FY20 (which will now change once the budget proposal is implemented in FY21), only 60% of the NPS corpus is tax-free. The remaining 40% mandatorily goes into buying an annuity which is taxable.
Let’s look at how NPS and EPF stack up.
EPF vs NPS
EPF and exempted PF trusts have been historically aimed at organized sector workers with basic salaries of less than ₹15,000. It is mandatory for employers to offer EPF to such workers. However, employers can also enrol higher paid workers into EPF.
The employer contributes 12% of basic salary plus dearness allowance to EPF and deducts another 12% from the employee’s salary; 8.33% of the employer contribution goes to Employees Pension Scheme (EPS) which earns no interest. Such contributions are tax deductible up to ₹1.5 lakh per year under Section 80C of the Income-tax Act. The interest accumulated is tax-free and so is the withdrawal, if the employee has rendered at least five years of continuous service and, from FY21, if the contribution is up to ₹2.5 lakh annually). The corpus can be withdrawn at age 58 or after two months of unemployment.
The interest rate is fixed by EPFO every year. Typically, it is in the 8-9% range. The rate for FY20 was 8.5%. Workers can also contribute more than the mandatory 12% deduction to Voluntary Provident Fund (VPF) which offers the same interest rate and tax benefits as EPF. The limit of ₹2.5 lakh will primarily affect people who contribute to VPF or are very high income-earners. According to news reports, the top 100 contributors have more than ₹2,000 crore in their EPF accounts. One of the highest contributors has more than ₹103 crore in his account, said the reports.
NPS, on the other hand, is a market-linked pension system. Contributions to NPS are tax deductible up to ₹1.5 lakh under Section 80C and up to ₹50,000 under Section 80CCD(1B). Returns on NPS fluctuate according to the returns on equities, corporate bonds and government bonds, which are the three asset classes in which NPS lets you invest. It matures at age 60, when 60% of the corpus can be withdrawn free of tax, and the remaining 40% must be used to buy an annuity (regular pension) product which is taxable.
“Finance Act, 2020 amended Section 17(2)(vii) of the Income-tax Act to cap the employer contribution to Recognized Provident Fund (RPF), Superannuation Fund (SAF) and NPS up to ₹7.5 lakh. Accordingly, the aggregate of such employer contributions exceeding ₹7.5 lakh per annum was made taxable as a perquisite in the hands of an employee,” said Parizad Sirwalla, partner and head, global mobility services – tax, KPMG in India. It is pertinent to note that withdrawal from these funds (RPF, SAF and NPS) may be taxable as per the prevailing provisions, subject to some conditions.
What should you do?
Returns on NPS are market linked. Over the past five years, equity schemes in NPS have given returns of 15-16%, corporate bond funds 9-10% and government bond funds 10-11%. However, these returns fluctuate considerably compared to the 8-9% interest historically paid out on EPF. “Maybe in the long run, employees will either contribute less to PF or shift to NPS for better earning opportunities,” said Sudhakar Sethuraman, partner, Deloitte India.
According to experts, the high interest rate continues to make EPF an attractive option even though the interest earned on contributions above ₹2.5 lakh is taxable. Amit Gopal, India business leader – investments, Mercer, said, “We expect to see continued flows to VPF driven by the high-interest rate (even post-tax). However, some segments of employees may move towards NPS.”
Experts suggest a combination of retirement products. “As per the scenario after budget, a salaried individual must first invest ₹2.5 lakh in EPF and VPF. Then, he/she can contribute ₹1.5 lakh to Public Provident Fund (PPF). If there is a surplus still, VPF will still be better than products like corporate fixed deposits post-tax. One can also invest in NPS considering the additional deduction available,” said Abhishek Soni, CEO and co-founder, Tax2win.in.
Rather than relying on a single retirement vehicle, high-income individuals may need to create a basket of products in order to reduce their tax outgo and maximize returns.
