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Saturday, February 20, 2016

With 8.8% tax-free returns, EPF can be bulwark of retirement plan

MUMBAI: The reduction in the interest rates on small savings schemes is bad news for investors. The interest rates were already linked to the government bond yields and were revised once in a year. Now they will be revised every quarter. Bond yields have been coming down in the past two-three quarters and the returns from NSCs and Kisan Vikas Patras are likely to fall further. Worse, the bi-annual compounding of interest on the NSCs and KVPs will now be done just once a year.

Many investors might also be disappointed by the marginal 5-basis-point hike in the interest rate of the Employees' Provident Fund (EPF). Even though the hike is less than expected, the 8.8% tax-free returns from the EPF make it the best debt instrument for long-term savings. The income from bank deposits is fully taxable, so the post-tax returns are barely 6-6.5%. Yet, these tax-unfriendly bank deposits account for 47% of the total financial assets of Indian households. Among small savings options only the Public Provident Fund comes close to matching the EPF with an interest of 8.7%. But PPF has an annual investment limit of Rs 1.5 lakh.

Its very design makes the EPF an ideal way to save for long-term goals. Contributions are linked to income, which means the subscriber automatically puts in more as his income goes up. More importantly, the contribution gets deducted from the salary and directly flows into the account. So the investor doesn't miss the money that never reached him.

In the long-term, the PF can work wonders for the disciplined investor. Let's assume a person starts a career at the age of 25 at a monthly salary of Rs 20,000. He will put Rs 2,400 a month into the PF, and his employer will match that contribution. Assuming his basic salary rises by 8% every year, he would have accumulated around Rs 3.5 crore in his PF account by the time he retires at 60. Though inflation would have pared the value of this money in 35 years, it can still fund a comfortable retirement. This calculation does not include the small portion that goes into the Employees' Pension Scheme every month.

The potential is huge, but not many PF subscribers are able to utilize it. They usually withdraw their PF balance when they change jobs. The money is usually blown away on discretionary expenses. Though the Employees Provident Fund Organisation is trying to encourage long-term investments, the onus is on the investor to resist dipping into the corpus.
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