Good idea to cap withdrawals at 75% levels
On the face of it, the Employees Provident Fund Organisation (EPFO) proposal to restrict premature withdrawals to 75% of the funds accumulated is unfair as the money belongs to the individual, not the EPFO. This, however, is not wholly true since there is a significant government contribution by way of tax rebates. An annual contribution of R100,000, by way of example, means a R20,000 tax-break assuming a 20% tax level since the contribution is deducted from an individual’s taxable salary. There is then the tax-free status given to the R8,750 of interest earned each year on the R100,000, assuming an 8.75% return—based on a 20% tax rate, that’s R1,750 of taxes foregone. Given annual contributions to the EPFO are around R100,000 crore, it is safe to assume the government is contributing at least another R10,000-12,000 crore to this, given that not all EPFO subscribers are taxpayers. In which case, allowing 100% withdrawals is tantamount to allowing subscribers to dip into government funds quite substantially.
Besides, like taxes, post-retirement savings are mandated by the government since, if individuals don’t save for their retirement, it will have to step in to look after them. Large premature withdrawals, however, have resulted in a situation where the average balances in the EPFO are very small at the time of retirement—indeed the annual pension that can be bought based on the average retirement balance is so low, the scheme might as well be scrapped. Central PF commissioner KK Jalan points out that the EPFO gets 13 million applications each year for withdrawing PF money and more than half these are for complete withdrawal. Given that there could be genuine emergencies—building a house or getting a child educated/married shouldn’t really be considered emergencies since they are planned well in advance—perhaps the best way to deal with this is to put in place penalties for withdrawing funds in exactly the way banks penalise depositors for liquidating FDs before the period of maturity. How much the penalty should be is a matter for EPFO to decide, but it should certainly take into account the large tax benefits depositors have got for an implicit promise—to keep the funds with EPFO till retirement—they have not fulfilled. This year’s budget has made a beginning in taxing premature withdrawals in case a member withdraws before completing at least 5 years of continuous payments—the National Pension Scheme, a competitor to EPFO, allows 3 withdrawals during an entire life but the gap between withdrawals has to be at least 5 years. An additional penalty also needs to be put in place for lowering of returns this causes; if a fund manager has to prematurely sell shares or liquidate deposits to meet the demand for withdrawals, this results in a fall in annual returns. As Jalan said during his media interaction, EPF is not a savings bank account, it is meant for post-retirement usage.