Employee Provident Fund (EPF) was introduced by the Government of India in 1952, under the Employee’s Provident Fund Act. EPF scheme promotes saving for retirement benefit for salaried employees. It secures employee interests and offers them future financial security.
How EPF works
Employee’s Provident Fund constitutes monthly employer and employee contributions. The employee contributes 12% of his basic pay and dearness allowance, to the fund. An equal amount is contributed by the employer towards the PF.
The employer contribution is split between EPF (3.67%), Employee Pension Scheme or EPS (8.33%) and Employee Deposit Linked Insurance or EDLI (0.50%).
An employee can choose to voluntarily contribute more than 12% of his pay, if he so wishes. This extra contribution is termed as Voluntary Provident Fund (VPF). VPF is also eligible for all the tax benefits that EPF enjoys.
This total contribution earns interest, the percentage of which is fixed by the EPFO (Employee Provident Fund Organization). The interest rate for FY 2018-2019 is 8.65%. It is interesting to note here that the interest rate of EPF is decided at the end of the tenor. The interest rate is based on the earnings of the fund (EPF) as a whole.
This is unlike other saving schemes like Public Provident Fund, National Savings Certificates, and others where the rate of interest is announced and known at the beginning of the tenor.
Benefits of EPF vs. Fixed Deposit
- High interest rate: The current interest rate for EPF is 8.65%, which is the highest interest rate offered under any scheme. However, senior citizen FD interest rate from Bajaj Finance is 8.95%, which is 0.35% higher than EPF interest rates.
- Flexible tenor: FD offers flexibility in tenor unlike EPF, wherein your money is locked-in till maturity. Flexible tenor options let you ladder your investments and build a corpus over a period of time. Moreover, with short tenors, you can also earn inflation-free returns easily.
- Tax benefits: PF contribution, by both employer and employee, is tax deductible under Sec 80C of the Income Tax Act, 1961. On maturity, the entire amount is tax-free and will not accrue any tax on the withdrawal. Interest earned on FDs is tax deductible under Section 80 C.
- Early withdrawal: It is possible to withdraw, partially or fully, the balance in your EPF account, before maturity. Premature withdrawal, in the case of certain financial crunch situations, is a huge benefit. However, this withdrawn amount is not tax-free if certain conditions are not met.
While early withdrawal will adversely affect your interest earning, you can easily take a loan against the FD up to 75% of the value in case of Bajaj Finance FD.
How to calculate interest on EPF Contribution
Pro-rata Interest
Though the EPF interest rate is announced annually, your monthly contribution earns interest on a pro-rata basis. Your contribution of Rs. 20,000 in April will earn you an interest of Rs. 161.50, with the interest rate being 8.65%. However, your contribution of Rs. 20,000 in the month of October (half-year mark) will earn you only Rs. 80.65, as the duration is halved.
Interest Compounding
Your monthly contribution towards your EPF account earns interest. This interest is compounded annually. It is credited to your account at the end of the financial year and will reflect in your account only after 31st March.
Fixed Deposits have the benefit of compounding interest quarterly.
An example of how to calculate PF contribution –
Basic Salary + DA Rs. 20,000
Rate of Interest (2018-19) 8.65%
Employee contribution to EPF (12% of 20,000) Rs. 2400
Employer contribution to EPF (3.67% of 20000) Rs. 734
Employer contribution to EPS (8.33% of 20000) Rs. 1666
Total contribution to EPF (2400+734) Rs. 3134
Monthly Interest (8.65/12) 0.721%
The interest is calculated on this total contribution, based on the opening balance of each month. Therefore, interest for April will be zero. For May, it will be (Rs. 3134+ Rs. 3134 i.e. Rs. 6268 * 0.721%) Rs. 45.10. For June, it will be (Rs. 6268+ Rs. 45.10+Rs. 3134 i.e. Rs 9447.10 * 0.721%) Rs. 68.11, and so on, in a similar way. It is then deposited into your account at the end of the financial year.
On maturity, when you get a substantial EPF corpus in hand, it is best to invest it a Bajaj Finance FD, to continue to enjoy a high interest rate of 8.95% for senior citizens.
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