In a Supreme Court ruling, earlier this month, the cap of Rs 7,500 per month on pension received under the EPS (Employees' Pension Scheme) was lifted. The pension to be drawn now depends on the last drawn pensionable salary (plus dearness allowance).
How have the EPS rules changed?
You may know that 12 percent of your basic salary (plus dearness allowance, if any) every month goes towards EPF (Employees' Provident Fund) and your employer will contribute an equal amount as well.
However, prior to the hearing, out of the 12 percent from the employer's side, 8.33 percent or Rs 1,250 (whichever is higher) went towards EPS while the rest was contributed towards EPF after a small portion (0.5 percent) is put aside for EDLI (life insurance).
Now, subscribers can opt to put the whole of 8.33 percent towards EPS instead of contributing the excess over Rs 1,250 towards EPF.
Further, the restriction of Rs 15,000 on pensionable salary was removed and the average pensionable salary will now be based on 12 months pay instead of 60.
The higher EPS contribution can be opted for by organisations with PF trusts as well.
Those who have recently retired can also opt to get a higher pension, provided, they return a proportionate amount of their EPF money.
Higher contribution for higher pension
Note that it is not that a higher portion of your take home salary will be deducted, but a portion that used to earlier go towards EPF will now go towards EPF.
Considering annual hikes in salary, you will be contributing a larger sum towards the fund every year.
You even have the option to make a backdated contribution towards EPS instead of EPF.
Should you opt for a larger pension?
You will receive your EPF contribution along with employer's contribution and interest earned on retirement in a lump sum on retirement.
On the other hand, the pension will be received on a monthly basis by the employee on retirement until he/she dies. Upon death, the pension will be given to spouse and two children below 25 years of age.
Considering the above, here are some important points to consider before you decide whether or not to opt for a higher pension:
- EPF contribution earns annual interest that is higher than any long term government scheme. The interest rate is revised every year by the EPFO.
- EPS being a pension scheme, contributions made towards it earns no interest.
- Employer's contribution towards EPF is tax free, and employee's share is eligible for tax exemption under section 80C of the income tax act. Additionally, the interest earned on EPF fund is tax-free when you remain a member for a period of at least five years.
- There is an option to withdraw money contributed towards EPF before retirement for specified purposes like child's education or marriage, medical treatment for self or family, construction of house, or repayment of housing loan.
- If you are financially savvy and expect yourself to remain so after your retirement, you can think of investing your EPF earnings on retirement in high earning investment options available in the future.
- If you are not confident of the decisions at the late stages of your life and do not wish to take the risk, a pension will give you and your family the required financial security in your old age that comes with regular income which shall continue to be received till you and your spouse dies. This is especially practical considering the increase in life expectancy.
- You can choose an annuity scheme (monthly payout scheme) from an insurance company to put your EPF lumpsum in. Earnings from these schemes are not substantial but will remain tax-free.
- Pension earned every month is fully taxable under the income tax act just like salary. It will not be beneficial for those in the higher tax brackets.
- Systematic withdrawal plans are more tax efficient than EPS for those in the higher tax bracket or expect to be included in the higher tax bracket later (considering salary hikes).
- Payouts from EPS are considerably higher than annuity schemes.
How can you make an informed decision?
Apart from your own financial needs and capabilities, you can approach the nearest the EPFO office once in a while and get an idea on how your salary has grown over the years. This will give you a better idea of how much of a shift in the contribution you should be making from EPF to EPS based on your salary.