Employee Provident Fund(EPF) and Public Provident Fund(PPF) are both Sovereign social security schemes primarily meant to encourage saving for ensuring post retirement financial adequacy and security. Both are highly secure funds but are not proof against interest rate risk.
Both schemes offer very favorable tax incentives. Subscription in to the fund are covered under the provisions of IT Act Section 80C. The accrued interest is covered under Section 10 of IT Act. Earnings at maturity are also exempt from income tax.
Employee Provident Fund
EPF is primarily meant for salaried employee both in the public as well as the private sector. It is compulsory for those drawing up to Rs 15,000 a month and for all employees in the public sector. Subscribers are required to pay at least 12% of the salary each month into the fund.
The employer is mandated to contribute 3.67% of the employees pay up to a ceiling Rs 550 per month (equivalent to Rs15,000 salary contribution). Interest accrued is compounded monthly but only for the current year i.e. the contribution both that of the employee as well as the employer’s earn interest only in the current year. The sum of the year end balances for each year of service is the entitlement of the employee at the time of superannuation. The current interest rate for EPF is 8.65%.
Public Provident Fund
PPF is like EPF but is operated by banks and not the EPFO. All citizens of India, including those eligible for EPF, are entitled to open PPF accounts. PPF account facilities are available in all public-sector banks and most of the private-sector banks. The minimum balance required to be maintained is Rs500 and the maximum annual limit is Rs1,50,000. The tenure of the fund is 15 years extendable in blocks of 5 years. The interest ,compounded annually, currently is 7.6%.
To compare the two funds, we need to do a sample computation of EPF accruals. Say an employee drawing Rs 15,000 pm subscribes Rs1800pm into the fund. His employee contribution will be Rs 550.
Since EPF is a percentage of the salary we assume that his salary increments by 5% each year. Also, promotions will increment his salary. For such an employee his entitlement after 30 years will be about 75 lakhs. Rs1800pm in PPF returns a maturity amount of about 25 lakhs.
To get 75 lakhs in PPF for the same tenure the subscription needs to be about Rs 5,000 per month. But this comparison fails to take cognisance of the fact that the EPF subscription increases every year and it becomes about Rs 8000 per month in the final stages. Even if we take the median subscription at Rs3500pm, EPF is a little better than PPF. But the advantage that EPF enjoys starts diminishing as the monthly subscription increases since the employee contribution does not increase beyond about Rs 550 as also due to the nature of compounding in EPF.
Hence the following is suggested: -
- Where EPF is mandatory subscription equivalent to Rs15,000 is desirable. Additional investment is better done in a PPF account rather than increasing EPF subscription.
- When EPF is not mandatory PPF is better when the potential for investment is beyond Rs2000.
- PPF is optimal at Rs10,000pm. This will return more than one crore in thirty years at current interest rates.
- Beyond Rs 12,000 pm other investment avenues must be found since it exceeds PPF limits and becomes sub-optimal from the taxation perspective.