The start of the New Year is also the time when the financial year starts drawing to a close. For many retail investors, it is also the time when they sit down to take stock of their finances and work out their tax-saving plans.
This year, small investors seem to have a number of options including inflation-indexed bonds, tax-free bonds, provident funds, savings certificates and fixed deposits. But with retail inflation at nearly 10 per cent, a thorough review of benefits and tax treatment is equally important to ensure that your money’s value is not eroded over time.
EPF’s High Interest Rate
On January 13, in a small bonanza to over eight crore salaried workers, the Employees’ Provident Fund Organisation (EPFO) increased its interest rate for 2013-14 by 25 basis points to 8.75 per cent from last fiscal’s 8.5 per cent return.
The increase may seem nominal, given that in previous years the interest rate on PF deposits has even touched 9.5 per cent, but the decision in effect means that contributions to the EPFO earn the highest interest compared to other instruments like the Public Provident Fund.
The 10-year National Savings Certificate is the only similar investment instrument to the EPF that offers a higher interest of 8.8 per cent in 2013-14. But interest on NSC is taxable after a period of five years. Up to five year, it is re-invested in the scheme and so is tax exempt.
“Keeping in view that interest rates of most small saving instruments like fixed deposits have remained largely stable, even a 25 basis point hike in the EPF rate should cheer the salaried class as it gives them some headroom in the current inflationary situation,” said Kuldip Kumar, executive director, PricewaterhouseCoopers.
What’s more, for over 56 lakh employees enrolled in around 3,000 exempt PF trusts, this is just the start — these trusts can declare an interest rate even higher than the EPFO’s 8.75 per cent in case they have surplus income to do so.
How the EPFO Works
So here’s the math. For salaried employees, employers deduct 24 per cent of basic wages that are capped at Rs 6,500 per month as contribution to the EPFO. This includes a 12 per cent contribution by the employer that is matched with an equal contribution by the employee.
The employer’s share of deduction is not taxable. Of this 8.33 per cent is contributed to the EPF while the remaining amount is invested in the related Employees’ Pension Scheme wherein workers are entitled to a pension after the age of 58 years, provided the deposits have continued for a period of 20 years.
However, employees can choose to increase the share of their contributions and get more than the mandated 12 per cent deducted from their salaries. All contributions to the EPFO are eligible for deductions under the Rs 1 lakh window provided under Section 80C of the Income Tax Act, 1961.
So even at a starting salary of Rs 25,000 per month and a standard deduction of 24 per cent of your basic salary, by the time you retire at the age of 60, your EPF kitty could have as much as Rs 1.8 crore and your EPS may have a corpus of Rs 2.3 lakh. For the calculations, we have assumed an interest rate of 8.75 per cent and a minimal 5 per cent increase in your PF contribution every year.
Even at the age of 50 years, when you may choose to build a house or marry off your child (for which you can withdraw a part of your savings), your EPF corpus will amount to Rs 63.5 lakh.
The other key comparative advantage of the EPF is that it falls under the exempt-exempt-exempt tax regime. In effect, this means that all contributions (subject to above mentioned limits), withdrawals and interest on these deposits are not taxable.
With the higher interest rate offered this year, there is a slight edge to the EPF compared to the PPF that is offering a return of 8.7 per cent in 2013-14 from its earlier interest rate of 8.8 per cent in 2012-13.
But do note that unlike, the slightly stricter withdrawal rules of the EPF, the PPF allows you to withdraw from the fifth year of contributions and the account matures in its 15th year that can be extended by a block of five years.
However, with retail inflation at nearly 10 per cent, the rate of interest on all such savings instruments is below the inflation level and concerns over erosion of the value of your investments are very real.
A word of caution: Salaried employees who wish to withdraw their PF contributions and avail the higher rate of interest of 8.75 per cent must wait for the final notification from the finance ministry. For those withdrawing their savings before this, the EPFO will calculate the 8.5 per cent interest rate for the previous fiscal.
In this regard, trade union leaders have sought a higher return on EPFO contributions and may even seek support from the finance ministry that has to finally approve the interest rate and notify it.
“There must be some relief for workers who are suffering from high inflation and they must get a higher interest on their retirement savings,” said AK Padmanbhan, president Confederation of Indian Trade Unions, who is a member of the EPFO’s Central Board of Trustees that recommends the interest rate.
But the EPFO is bound by its norms that do not allow for a higher interest rate to subscribers than the actual income of the fund. “We have estimated an income of Rs 25,048.55 crore for 2013-14. EPFO would require Rs 25,005.41 crore for providing 8.75 per cent rate of interest for this fiscal and leave a surplus of Rs 43.14 crore,” said KK Jalan, central PF commission.
Apart from the PF, investors have other obvious choices such as the recently launched inflation-indexed bonds that promise to give a higher return. Though these bonds are taxable like fixed deposits, but their return would be higher.
The ten-year bonds, offer interest in two parts — the inflation rate and a fixed rate of 1.5 per cent. It has been structured in a manner that even if the inflation goes into negative, investors will continue to get 1.5 per cent which is a fixed rate.
Retail investors, including individuals, Hindu undivided family and charitable institutions can invest a minimum of Rs 5,000 while the investment amount can go up to Rs 5 lakh per investor.
The RBI has also extended issuance of these products to March 31, 2013 from the earlier deadline of December 31, 2013 and is also looking at making it more attractive though this may not happen this fiscal.
The last quarter of the fiscal (January to March) is also when a host of financial institutions such as NHAI, IRFC, National Housing Board and HUDCO start the sale of tax-free bonds. The bonds have a coupon rate of about 8.5 per cent 9 per cent and require you to remain invested for at least 10 years. Interest income on these instruments is tax free. The instruments can be considered a good option once the EPF and PPF limit is exhausted.