EPF is changing how does it affect you?

You may end up contributing more even as withdrawals get harder

Most of us get our salaries after the mandatory deduction for Employee Provident Fund (EPF) and taxes. Some changes that could impact these savings have been notified by the EPF Organisation a few months ago. The Finance Minister also made some proposals related to the EPF in his Budget speech this year. An amendment Bill to the EPF Act is likely to be tabled in the Parliament session commencing on April 20 as well. This is the time to pay more attention to the EPF.

Limits and definition

We all know that every month, 12 per cent of the Basic Pay and Dearness Allowance (DA) is considered contribution to the EPF and is deducted from our salary. The employer too makes a matching contribution in the employee’s name.

Until August 31, 2014, the ceiling for compulsory enrolment in EPF was fixed at ₹6,500 (Basic +DA). So if your pay was above this limit, you had the choice to either not contribute to the EPF at all or to contribute only up to the ceiling of ₹6,500. Your employer also had the choice to not offer the scheme at all if your pay crossed the limit. But once enrolled, you were not allowed to pull out of the scheme when continuing to be in employment. The same rules apply now. Only that the ₹6,500 ceiling has been revised to ₹15,000 from September 1, 2014.

A proposal to include all allowances instead of only the Basic and DA for the 12 per cent calculation is doing the rounds right now. If the Labour Ministry finds a consensus on this, the proposal could well become part of the amendment Bill to the EPF Act likely to be placed in Parliament later this month. The move is aimed at employers who freeze basic and DA and give hikes only through allowances, thereby limiting their PF outgo. Plus, given that EPF is a long-term savings vehicle with tax deduction on initial investment (for employee contribution), tax-free interest and withdrawals (if pulled out after five years), it also bats for the government’s thrust on social security visible in the recent Budget.

But practising chartered accountants we spoke to say that the proposal to include allowances may not go through; employers may resist the higher outgo from their pockets, as they too have to give a matching contribution. Even if it is implemented, some employers could exercise the option of not offering the scheme to at least their new employees above the threshold limit, to cut down on their outgo. For employees under the scheme, the higher EPF contribution from their side could cut take-home pay; but the move would be beneficial as it adds to the long-term savings.

No pension for new employees

If you are an existing member, the EPF corpus and interest earned thereon will be handed back when you retire. This apart, the scheme entitles you for a pension if you have put in at least 10 years of service. While the 12 per cent of Basic and DA pulled out from your salary entirely goes to the EPF, 8.33 per cent of the 12 per cent employer contribution goes towards the Employee Pension Scheme. The Central Government also chips in with a 1.16 per cent contribution for your pension. But both the employer’s and the government’s pension is linked to the new ₹15,000 limit since September 2014 (₹6,500 limit earlier). This cap applies unless the employer and employee have specifically agreed that the pension contribution will be on a higher sum (rarely done). Hence, if your basic and DA is ₹20,000 per month now, employer’s contribution towards pension will be ₹1,249.5 (8.33 per cent of ₹15,000). Employer’s contribution to the EPF will be ₹1,150.5 (₹20,000 x 12 per cent – ₹1,249.5). If your Basic and DA increases to ₹25,000, pension contribution will still be ₹1,249.5. Only the EPF sum will go up.

The big change on this front is that the pension option has been withdrawn for new employees joining the scheme after September 1, 2014, if their basic and DA is higher than ₹15,000. Entire 12 per cent contribution of the employer will now go towards EPF only.

The removal of the Pension scheme is a welcome move. For one, the pension money paid by your employer throughout your working years does not earn interest. Hence even as the scheme has its own formula for pension calculations, this non-earning of interest plays a role in limiting the monthly pension amount later on. Secondly, for existing employees quitting mid-way, say, to start their own business or retire early, the pension amount will be locked in till they turn at least 50. Rules of the pension scheme are such that if you quit after 10 years of working, and don’t plan to join another organisation, you cannot close the pension account. You need to wait till at least when you turn 50 (when you will be eligible for a pro-rata pension) or if possible till 58 (for full pension), to claim it. A proposal to increase this pensionable age to 60 doesn’t make things better for existing employees covered under the pension scheme.

Pat for NPS over EPF

The move to cut the pension scheme could also be aimed towards slowly shifting the burden of providing for your retirement from the government to the individual. The granting of additional tax deduction of  Rs50,000 for investment in the New Pension Scheme (NPS) in the Budget apart from the Rs1.5 lakh 80 C deduction also points to this line of thought. NPS can invest in a combination of equities (up to 50 per cent) and debt, according to your risk appetite. When you turn 60, at least 40 per cent of your savings should be invested in an annuity scheme from an insurer, which will give you periodic cash flows. The remaining can be withdrawn as lumpsum anytime up to the age of 70 years. If you withdraw earlier than 60, 80 per cent of the amount has to be used for purchasing an annuity for providing monthly income. Earnings are tax free but withdrawals are taxed.

In the Budget this year, the Finance Minster spoke about bringing an enabling legislation to help employees opt for either the EPF or NPS. So EPF may not be the only choice your employer can provide you with in future. Instead, he could perhaps offer Corporate NPS too. In corporate NPS, both you and your employer or any one of you can contribute any convenient sums each month (minimum ₹500). Both parties also have the choice to choose the fund managers and the proportion to be allotted to debt and equity for the contributions. The incentive for the employee to invest in the corporate NPS would be two-fold. One, like the EPF, you can claim tax deduction for your own contribution, up to 10 per cent of Basic and DA (within the 80C limit of ₹l.5 lakh and the additional ₹50,000 for NPS). You can also claim deduction on employer’s contribution up to 10 per cent of Basic and DA. This deduction is outside the ₹2 lakh mentioned above. This feature is not available under the EPF. The incentive for the employer to offer the corporate NPS is that a contribution of up to 10 per cent of your Basic and DA can be deducted as business expenses in their Profit and Loss Account.

One reason why corporate NPS has not been popular so far is because companies were already putting money into the EPF and the linked pension scheme. Besides, employees have also been slightly wary as NPS withdrawals are taxable unlike EPF withdrawals, which are tax-free after five years. But since NPS is a market-linked product, it may make up by providing superior returns than the EPF over the long term. EPFO’s investments are restricted to government securities, PSU bonds, etc. Only now has the EPFO announced that it will likely invest 5 per cent of its incremental corpus in exchange-traded funds.

The measures related to the choice between EPF and NPS are expected be a part of the amendment Bill. So one needs to wait and watch on how the government proposes to go about this, whether it would cover only new employees or if existing ones would also get a window.

Disincentive for withdrawals

The EPF offers the flexibility of withdrawals. You can withdraw for higher education or marriage of children or to purchase or construct a house. Your EPF contribution can even be used to finance your life insurance policy premiums. When you leave your job, you can withdraw the entire EPF sum lying to your credit after a two-month wait period. Many exercise this option if they plan to be self-employed and not join any other organisation.

These withdrawals are tax-free, if they are made after five years of continuous membership. If withdrawn within five years, you will have to pay tax on the employer's contributions to the EPF during the earlier years. Tax benefits claimed earlier on your own contributions will also be lost. You will have to pay tax on the interest earned on both parties’ contribution as well.

The Budget has introduced a 10 per cent tax deduction at source (TDS) on EPF withdrawals (within five years) over ₹30,000 from June 1, 2015. But while being able to dip into it is a good idea, you must keep in mind that it will affect your retirement corpus. To discourage withdrawals from the EPF, there is a proposal to withhold 10 per cent of the fund till the subscriber turns 50.