As we all are now clear that contributions rendered by employees to the Employees' Provident Fund (EPF) above Rs 2.5 lakh would allow the interest earned to be taxed above the maximum cap as per the update by Budget 20-21. Planning for retirement can be accomplished in varied contexts. One part of the tale is a blend of investment options such as FD, government funds, mutual funds and so on. But here we are talking about smart means of preparing for retirement i.e. the Employees' Provident Fund (EPF) and the National Pension System (NPS). Since both the NPS and the EPF are regulated by the government, different criteria vary from each other. But let's differentiate both in-depth to make your retirement planning decision smarter.
The rule of the Provident Fund has been in effect for many decades and is required to be delivered to its employees by an employer. For employees with a minimum wage of less than INR 15,000 p.m., it is mandatory for an establishment having more than 20 employees to contribute to EPF. Employees who receive a basic salary above this limit can contribute towards EPF. Pursuant to Section 80C of the Income-tax Act, such contributions are tax-free up to Rs 1.5 lakh per year. The accrued interest is tax-free and even the withdrawal if the employee has supported continuous employment for at least five years within a contribution limit of Rs 2.5 lakhs annually. At age 58 or after two months of unemployment, the corpus can be withdrawn by the employee. The interest rate is determined annually by EPFO, i.e. the rate for FY20 was capped at 8.5%. Employees can also consider Voluntary Provident Fund (VPF), which provides the same interest rate and tax incentives as the EPF, with more than the standard 12 per cent deduction. As a voluntary contribution to the EPF, the employee can also donate 100 per cent of his/her minimum wage. But the Rs 2.5 lakh cap will mainly impact individuals who contribute to VPF and have a high income.
NPS is a pension scheme where the pension benefits are linked to the market. NPS contributions are tax-free under Section 80C up to Rs 1.5 lakh and under Section 80CCD(1B) up to a limit of Rs 50,000. NPS returns vary significantly as per equity, corporate bond and government bond performance, which are the three asset groups that NPS enables you to allocate in. Contributions towards this retirement fund mature when you hit the age of 60 where you can make a tax-free withdrawal of 60% from the corpus and the remaining 40% should be used to purchase taxable annuity products. Compared with the 8-9 per cent interest historically delivered by EPF, NPS returns vary significantly, considerably NPS is a voluntary contribution system with a minimum deposit limit in Tier I of Rs 500 and in Tier-II accounts of INR 1,000.
You can withdraw all of your EPFO corpus upon meeting the retirement age. The NPS, though, is organized as a pension scheme. Thus, at retirement, you can make a tax-free withdrawal of 60% of your accrued corpus. The 40 per cent left must be used to purchase an annuity product as we discussed above. For those who wish to use a large portion of the retirement corpus for financial purposes such as owning a house or financing the marriage of children, NPS can't be a smart bet here. In certain situations, proceeds from the EPF are considered for financial objectives rather than covering retirement life.
No doubt NPS has achieved in respect of returns over EPF in the last two years, but its yields compared to EPF are not secure and fixed. Early-age investors should contribute towards NPS and settle for a high allocation of equity to build a massive corpus to meet retirement plans. If you are not willing to take market likelihood in the final decades of your employment, then you can consider EPF. Returns under PF are set at the interest rate decided annually by the government. The return from NPS, however, depends on the NAV of equity and debt. Therefore, since PF provides secure and guaranteed returns, NPS provides risk and higher returns. Even though the interest received from contributions above Rs 2.5 lakh is taxable, the acceptable interest rate proceeds to render the EPF a smart decision. Considering the additional deduction open, one can contribute to NPS as well. High-income investors must diversify their holdings instead of focusing on a single retirement vehicle to minimize their tax exposure and optimize returns. Investors must consider first his or her risk appetite, lock-in, liquidity, maturity and so on of the investment vehicle before opting a one.