17 May 2016

Should you opt for Employee Provident Fund at all?

The biggest plus for EPF is the forced saving nature of the product and the tax breaks.

Signing on the employee provident fund (EPF) account opening form is considered a routine part of joining any organisation. Most people who join from another organisation routinely transfer the EPF account from the old organisation to the new one. Very few employees are aware that they have a choice of not joining the EPF in their new job if their basic salary is higher than Rs 15,000 per month. This choice to refrain from joining the EPF is available to employees when they join another
organisation even if they were part of the EPF at their earlier employer. The only catch is that this choice can be exercised only at the time of entering the new employment. Once having joined the EPF in the new employment you are not allowed to opt out of it later. It is not for nothing that the finance minister remarked that "The EPFO does not have subscribers – it has hostages". Hence, it is very important for you to know about this choice being available to you as well as whether you should exercise that choice.

I am giving below some factors that you should consider before deciding on this matter. Firstly, I am assuming that your employer's contribution is a cost to company employer. Which means that if you choose to opt out of EPF they will pay you the amount equivalent to the employer's contribution to EPF as salary instead. Secondly I am assuming that your Basic is higher than Rs 15,000 per month as the choice to opt out of EPF is only available if your Basic is higher than Rs 15,000 per month.

Let's examine the pluses and minuses of joining the EPFO.

The biggest plus for EPF is the forced saving nature of the product and the tax breaks. The employer's contribution is tax-free and your own forced matching contribution is eligible for tax deduction along with other items such as life insurance premium, tuition fees, etc. For most people the fact that both the contributions are deducted from the salary every month and only the net salary is paid is a good enough reason to opt for the EPF scheme. They don't trust themselves to invest the money regularly should it be paid to them instead of being contributed to the EPF. They are apprehensive that they will end up spending the money instead of investing it if it is paid to them. This is not as unimportant as it sounds. Forced savings has been used by the life insurance industry for decades now as a major positive to justify their product.

However, unlike life insurance policies EPF provides a reasonable return (it is around 8.8% for last year) which is normally around inflation and is exempted from tax. This considerably adds to the forced savings argument considering that the return is tax free.

Having said that we have exhausted the list of pluses in favour of EPF. Let's look at the minuses.

Few people are aware that Rs 1,250 per month out of the employer's contribution is not credited to your EPF account but to a common pool of employee pension scheme. This pension pool cross subsidises the lower contributors by allowing them a minimum pension of Rs 1,000 per month (irrespective of their contributions) and restricts the maximum pension of the higher contributors to Rs 3,250 per month. There is nothing wrong in the subsidising and providing a minimum pension to the relatively weaker sections of society but just remember the subsidy is coming from you and not from the government. The effective return on this contribution is negative if you begin the maximum contribution fairly early in your life. The return is quite low even with the most optimistic assumptions. This impounding of your money at nil or low rate of interest manages to even out the exclusive tax benefit available for employer's contribution.

The administrative inconvenience of dealing with EPFO is too well known to require any repetition here. Though it has improved quite a lot from the old days, still when you have an option to invest or not you will definitely take the service aspect of the investment firm into account. Not even EPFO itself is likely to claim it's investor services are better than any other investment organisation that you might deal with.

The biggest minus is that the return is just about matching inflation and it does not really grow your wealth as any long-term investment product should. You can run the numbers on any assumptions and find that it is not that difficult to beat the corpus accumulated by EPF by choosing other tax advantaged options such as retirement funds notified under Section 80C which have similar risk profiles as EPF investments. Of course, if you are willing to invest in equity-linked savings scheme the retirement corpus accumulated over the long term can be much higher.

In other words, the only reason to opt for EPF is if you agree with the forced savings argument.


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