A phone call between two friends leads to a conversation on how interest on the popular retirement product for the salaried, the Employee Provident Fund (EPF) is calculated.
Akhila: I am planning to increase my contribution towards the EPF voluntarily since it offers a good interest rate and has taxation benefits too. I saw your recent tweet that the EPF account will be split into two separate accounts. What is it all about?
Karthik: First things first. Did you know that the interest on PF contributions beyond a point is taxable now?
Akhila: Oops.. No! My eye have been on the high interest rate that the scheme has been offering - 8.5 per cent for FY21 - and the belief that it continues to be one of the last bastions of high fixed returns.
Karthik: You didn’t know?!
Earlier this year on budget day, the government announced that the interest earned on an employees’ PF contribution of over ₹2.5 lakh a year would be taxable. This threshold also includes contributions to the Voluntary Provident Fund (VPF), which you can make at your own will beyond your usual 12 per cent contribution
Akhila: Oh!! Good you told me. So, investing in VPF will not be as attractive as it used to be earlier, right?
Karthik: Yeah. The EEE (exempt-exempt-exempt) status will no longer be applicable on contributions exceeding the threshold.
Akhila: Uh oh! So, from when is this new rule applicable?
Karthik: The new rule will be applicable on all such contributions starting from the current financial year (2021-22).
Akhila: Oh! Is this why the government wants separate accounts within the provident fund account?
Karthik: Bang on! The balance as on March 31, 2021 and the contributions made thereafter upto the threshold, will not be impacted by this new rule. This will be put into the non-taxable contribution account.
The taxable contribution account will comprise employee contributions in excess of ₹2.5 lakh every year.
Akhila: I understand. Now, that interest on both EPF and VPF contribution beyond a certain limit is taxable, what do you think is the next best safe and tax-free fixed income avenue to build my retirement corpus?
Karthik: You can consider the public provident fund (PPF), given its attractive return. The scheme has a 15-year maturity. Investment in PPF is eligible for tax deduction under Section 80C of the Income Tax Act. Interest earned and the maturity amount are also tax-exempt.
Akhila: What is the rate of interest on the PPF?
Karthik: The PPF currently offers 7.1 per cent per annum. The interest payable is revised quarterly by the Centre, but usually the rates have been at a premium to bank deposit rates, for instance.
Akhila: This looks like a good deal.
Karthik: You can probably contribute to the VPF until the ₹2.5 lakh limit is breached and put the balance amout into the PPF.
Akhila: Ok. Any limits on PPF investments?
Karthik: Good question. You can invest only upto ₹1.5 lakh per annum in PPF.