For a very long time, the Employees’ Provident Fund (EPF) was the logical method of saving for retirement. With a 12% tax-free contribution by the employee and a matching 12% tax-free contribution by the employer, it was an absolutely tax-efficient option for employees. In addition, the interest paid on the EPF was also fully tax exempt in the hands of the investor. All these made a lot of sense as long as EPF was paying market rates of interest.
Over the last few years, however, the rates of EPF have been coming down consistently for 2 reasons:
1. General rates of interest in the economy have been falling
2. The government is keen to overcome the distortion in debt markets.
For the latest financial year (2018-19), the EPF rate of interest stands at just about 8.65% (as approved by the Finance Minister recently), although the tax benefits for the employee continue at the same level. Now, therein lies the problem. Apart from EPF, there are other investment options for the employee where tax benefits can be derived and the corpus can also be made to grow consistently.
Should You Worry?
Whatever be the case, financial experts say that EPFO manages a huge corpus of retirement funds of employees in India. In fact, it is the world s largest social security organisation having more than 17 crore accounts. These funds promise a fixed interest to the depositors, determined every year by the Finance Ministry. The Finance Ministry has recently ratified 8.65% interest on EPF for 2018-19 — the first increase during the last 3 years. The interest rate on EPF was 8.55% in 2017-18, 8.65% in 2016-17, and 8.8% in 2015-16.
Over the last two decades interest rates have gradually but surely come down. While this phenomenon of falling interest rates is very encouraging for investments and economy as a whole, it raises concerns over the sustainability of high fixed return instruments like EPF. In fact, currently debt paper of triple A rated companies would fetch a rate slightly lower than the promised interest rates. So, should one be concerned about the security of one’s money lying with EPFO?
This concern, according to me, is not a very serious one on account of the following two factors. Firstly, EPFO is a government organisation set up by an act of Parliament. The onus of ensuring that all drawdown in returns are adequately accounted for and corrective action is taken rests with the government of the day. In a democratic set up, no elected government can mess up with such large savings spread across so many depositors, says Ashish Kapur, CEO, Invest Shoppe India Ltd.
Secondly and more importantly, all these concerns were in fact more valid till 2014. Beginning from the financial year 2014-15, the Government of India took a historical step to start investing a part of their incremental additions in equity markets. It started with a 5 per cent contribution which has gradually increased to 15 per cent. There are chances that this limit may be further hiked to 25%. Equity investments are known to generate high returns worldwide over longer periods of time. In India over the last 30 years, equities have generated higher than 15 per cent average annualised returns.
Even if these returns were to moderate a bit going forward, it is safe to assume that the equity part of the total corpus would certainly achieve a much higher rate of return than the promised interest rate. That would more than offset any drawdowns that may happen on the larger part of the corpus which is being invested in high-quality debt instruments. Also, kindly note that equity investments are currently not going beyond the Nifty or Sensex stocks. This ensures not only stability and high quality of stock selection, but also majorly removes risks and chances of errors in stock selection, says Kapur.
Experts, therefore, say that EPF contributions are absolutely safe and secure, and depositors need not worry at all.
The Question of Debt Vs Equity
Still the question remains: Is EPF good enough for your retirement? Or, you need to look for some other options also?
According to financial experts, the Indian saving pattern has a unique kind of distortion in its basic structure. For example, people have been using debt investments like EPF and PPF for long-term retirement savings. However, it is in the long term that equity as an asset class performs really well.
Therefore, to look at debt as an investment in the long run goes against the basic grain of risk-reward ratio. In reality, your long-term money should be invested in equities while your short to medium-term monies can be invested in debt. That is where products like Mutual Fund ELSS can come in extremely handy. Like EPF, the ELSS funds also provide Section 80C benefits, says Ketan Shah, Chief Revenue Officer, Angel Broking.
Of course, the dividends are subject to withholding tax at 10% while long-term capital gains are now subjected to a 10% flat tax above Rs 1 lakh. But ELSS provides you the benefit of superior returns in the long term compared to EPF. When it comes to your long-term financial plan, it is all about making money work hard on your behalf. That is something only an ELSS can help you with, adds Shah.
While EPF can continue as a statutory contribution, you need to remember equities will give higher return in the long term, irrespective of the robustness of the economy and the strength of the markets. To that extent, it is essential to blend EPF with ELSS. Secondly, the rate of interest on EPF is 8.65%, which is not a very good return and may again come down in the future. That is something most of you relying on EPF investments need to be cautious about, says Shah.