Budget Impact: EPF gets hit in more ways than one

The Budget has created quite a stir by proposing a tax on Employees Provident Fund (EPF) withdrawals on contributions made from April 2016. Later clarifications have given rise to more questions than answers. The Finance Minister has promised to clear the air in Parliament. But don’t be too hopeful of major changes.

The government has been poking holes in the EPF in quite a few ways in recent times. The message from these tweaks seems to be that we now need to rely less on government agencies like the EPFO, to save for retirement.

It is common knowledge that 12 per cent of your basic pay and dearness allowance (DA) go towards your EPF account every month and a matching sum is put in by your employer.

But actually, 8.33 per cent from the employer’s contribution goes towards the Employee Pension Scheme and only the remaining goes into the EPF.

But this pension option was withdrawn for new employees whose basic pay plus DA exceeded ₹15,000, who joined the workforce from September 1, 2014.

This move to remove pension benefits for higher-income employees should be seen as the first signal that the onus of retirement savings is to shift from the government to the individual.

The second move in this direction are measures to make the market-linked New Pension System (NPS) more attractive. The additional tax deduction of ₹50,000 for investment in NPS in Budget 2015 outside of the ₹1.5 lakh 80C deduction points to this line of thought.

When you turn 60, at least 40 per cent of your NPS corpus is required to be invested in an annuity scheme from an insurer within three years.

The remaining can be withdrawn as lumpsum anytime up to the age of 70. Earlier, the entire corpus was taxable on withdrawal.

But Budget 2016 has helped NPS investors breathe easy by declaring that 40 per cent of the corpus will be tax-free on withdrawal. Besides, NPS was tweaked in mid-2015 by relaxing pre-mature withdrawal rules.

Earlier, if you withdrew before the age of 60, 80 per cent of the amount had to be used for purchasing an annuity. But the relaxation announced last year said that you could withdraw up to 25 per cent of your contribution (for specified expenses such as child’s education, illness, etc) if you have been with the NPS for at least 10 years.

A total of three withdrawals with a gap of five years between each have now been allowed.

At the same time, EPF withdrawal rules were made more stringent in early February 2016 just before the Budget.

Say, you are 30 now and 10 years later, you decide to quit working as you have a business idea and dream about being an entrepreneur. Earlier, you could withdraw your EPF balance entirely when you left a salaried job and didn’t join another.

Recent changes now mandate that only the employee’s contribution and interest thereon can be withdrawn this way.

The employer’s contribution will be locked in till you turn 58.

The intention seems to be to protect at least part of the retirement nest-egg and perhaps make up for the removal of the pension scheme for new employees in some way.

But it raises two questions. One, why would someone withdrawing his contribution and interest at an early age be keen to buy an annuity to avoid paying taxes?

Two, even when one withdraws the employer’s contribution at 58, if one has to buy an annuity to avoid tax, the much smaller size of the corpus may not fetch a decent monthly annuity.

Tightening rules for the EPF mean that you can no longer ignore the NPS as a retirement option.

Unlike the EPF which gives out interest at declared rates by the government, you can choose to invest a greater sum in equities in the NPS and earn higher returns if you have the risk appetite. If your employer offers the Corporate NPS option instead of subscription to the EPF, you can consider that too.

This apart, you can also diversify savings for your retirement by investing in the PPF, which is run by the post office.

Although interest rates for PPF are proposed to be reset every quarter, it is among the few instruments that offers tax exemption for investment, interest and withdrawal presently.

You can also invest monthly sums in good mutual fund schemes to build a retirement corpus.