The government of India enacts the Employee Provident Fund law in 1952. The aim was to provide social security scheme to the salaried class. It was a form of ‘forced saving’. However, the intention of the government was noble. The government wants to secure the future financial needs of the salaried employees.
The basics of employee provident fund
Employers compute the cost to company (CTC) as the amount an employee costs to the company. It is the amount that the company spends directly or indirectly on you, because of employing you.
However, employers deduct some portion of your CTC before paying to their employees. Furthermore, EPF is the major deductible component, probably after TDS (tax deductible at source).
The breakup of EPF contribution
EPF constitutes, up to 12% of the basic salary as employees contribution. Also, the employer makes an equal contribution for each of their employee. It is important to note that typically, the basis of an employee varies from 40 to 50% of the CTC.
However, every employer deducts the employer contribution from every employee CTC for tax computations. And the EPF contribution is completely exempt from income tax. Also, the employee contribution is exempt to the limits as per income tax section 80c.
There is a maximum wage limit of INR 15000 for mandatory contributions to EPF. But, many companies do not give this as an option to employees earning higher than INR 15000. It is mostly due to factors well known to all of us. All of us, who have had interactions with government agencies.
Why EPF is a good option for salaried class
EPF is low-risk investment option. The government of India backs the provident funds for employees. So all your money has high safety. It has low volatility, as interest rate revision is considered only once a year.
The central government fixes the rate of interest on the provident fund. This the central government fixes after consulting the Central Board of Trustees, Employees’ Provident Fund. This is done every year during March or April. You receive the interest in your EPF account on monthly running balance with effect from the last day in each year.
Comparison of EPF interest rate with Inflation
The below graph compares EPF interest rate and inflation change since 1981. Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. In this chart, the inflation is computed from Cost Inflation Index published by the Income Tax Department of India. Cost Inflation Index(CII) is a measure of inflation that is used for computing long-term capital gains on the sale of capital assets
Few key takeaways –
1. The value of your investment is reduced during the year 2009-2014 due to high inflation and low EPF interest rate
2. Taxing the EPF withdrawal at the end of the tenure and withdraw will result in further value degradation
3. With presence economy indicators and interest rate movements, it is very much likely that the EPF interest rate will only reduce in future
4. It is necessary for us to think of alternative long-term investments which can give returns better than inflation