EPF interest in tax net: Where should high-income earners invest for retirement now?
Budget 2021 has a proposal to tax the interest earned on employees’ PF (provident fund) contributions of more than Rs 2.5 lakh per year. This came as a bolt out-of-the-blue for high earners who used to over-utilize this tax benevolence of the government till now.
EPF has no doubt been a pretty lucrative investment option, as it gives tax-free 8.5 percent returns with a sovereign guarantee. What more can investors ask from their debt investments for their retirement portfolios?
If an employee’s mandatory PF contribution itself is more than Rs 2.5 lakh a year, then there isn’t much choice. The new tax will be triggered automatically for the interest earned from contributions in excess of Rs 2.5 lakh, and for such persons, there is no option but to pay the tax.
However, for those who have some flexibility in making contributions, there are a few options available.
Retirement investment alternatives
There is no one right investment for everyone. Depending on a person’s income structure and investment requirements there are different alternatives. Also there must be different asset allocation for different goals.
VPF (Voluntary Provident Fund) is a good alternative. Yes. You read it right. And there is no denying that if your EPF + VPF contributions exceed Rs 2.5 lakh, the interest would be taxed. But, even then, VPF contributions are still a pretty reasonable option, given that for 20 percent and 30 percent tax slabs, VPF still delivers 6.80 percent and 5.95 percent, respectively. Not a very high post-tax rate, but still better than many other non-risk-free debt options available such as bank FDs, bonds, NCDs and debt funds. Given the low-rate interest scenario EPF ( plus VPF) returns are attractive even though the interest earned on contributions above Rs 2.5 lakh will now be taxed.
Then, there is the PPF (Public Provident Fund). It still gives 7.1 percent interest and it’s still not taxed. This is better compared to the VPF post-tax rate. But you can’t invest more than Rs 1.5 lakh in PPF. So, if you only have a small amount in excess of Rs 2.5 lakh to invest, then PPF is better for you. But if you are a high-earner, then PPF won’t be of much help beyond allowing you to invest in excess of Rs 1.5 lakh. You will still have to figure out something for investments above that amount.
Then there is the NPS (National Pension System). It’s a post-retirement income product that provides for a market-linked pension system. It allows the investor to choose an asset allocation between equity and debt. Being retirement specific, it matures at age 60, but has some restrictions on utilization of corpus on maturity. Only 60 percent of the NPS corpus can be withdrawn tax-free, while the remaining 40 percent must be used to buy an annuity (pension) product to provide taxable pension-income. Nevertheless, it can still be useful. How? If one is already investing in equity funds, then one can set conservative allocation for NPS (that is in schemes G and C only) and invest the amount above Rs 2.5 lakh in NPS. Many employers offer NPS in addition to EPF.
So one can divert the excess part of employee contribution to conservatively-allocated NPS. For those who have no other exposure to equity, equity in NPS allocation can be considered. Since equity in NPS is expected to deliver higher-than-debt kind of returns in the long run (as NPS returns are market-linked), it’s possible that over time, many aggressive investor ‘employees’ will contribute less to provident fund and more to NPS.
Then, there are suitable debt fund categories that can deliver better post-tax returns in the long run. But being market-linked, they aren’t risk-free and that is something that investors need to understand when comparing them with risk-free options such as EPF and PPF.
Having a combination of suitable retirement products might be a good approach. So, employees earning high salaries can opt for a mix of EPF (+VPF), PPF and NPS to optimize returns, with an eye on taxation of interest and maturity amount. This can be one possible strategic alternative.
Source : Money Control