For Past couple of days, both EPF – Employees Provident Fund & EPS – Employees Pension Scheme has been in a lot of news and discussions primarily due to Supreme court judgement – News Article. This judgement allowed Mr Praveen Kohli to get a 1200% hike in pension primarily because, in October 2016, the Supreme Court directed the EPFO to increase the pension of 12 petitioners as per a 1996 amendment that should have increased their EPS contributions.
Employees’ Provident Fund—commonly called PF—is a retirement benefits scheme that is available to all salaried employees. It is a very important tool of retirement planning. The tax-free interest (compounding) and the maturity ensures a good growth of our money. And Employees pension scheme (EPS) is a component of the employee provident fund that provides a pension to its subscribers.
Both employees and the employer contribute to PF at the ‘rate of 12%’ of the basic wages and dearness allowance (if any) per month. Thus, the total contribution to PF is 24% per month. PF provides retirement benefit to us to secure a better standard of living at retirement.
However, there are many things about EPF which most of us are unaware of. The below article provides you more information about EPF such as how the contributions are calculated based on basic salary and DA, what are the EPF interest rates, what is pension scheme, etc.
EPF & EPS
Most organisations today offer the facility of Provident Fund. EPF (Employees’ Provident Fund Scheme 1952) and EPS (Employees’ Pension Scheme 1995) are the two different retirement saving schemes under Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, meant for salaried employees. It is mandatory for every employee drawing a basic pay of up to Rs. 6,500 per month to make a contribution towards EPF & EPS. However, employees drawing basic salary over Rs. 6,501per month have an option to get PF deducted from their salary.
Normally, both the employer and employee contribute 12% each of the ‘basic salary’ of the employee plus DA (if any). The entire 12% of employee’s contribution is added towards EPF, while 8.33% out of the total 12% of the employer’s contribution is diverted to the EPS or pension scheme and the balance 3.67% is invested in EPF.
However, if the basic pay of an employee exceeds Rs. 6,500 per month, the contribution towards pension scheme is restricted to 8.33% of Rs. 6,500 (i.e. Rs. 541 per month) and the balance of employer’s contribution goes into EPF.
Thus, the employer contributes only up to Rs. 541 per month (8.33% of Rs. 6,500 in the employee’s pension scheme account.
Contribution to EPF & EPS
Scheme Employee’s contribution of basic pay Employer’s contribution
EPF 12% 3.67%
EPS 0% 8.33%
Let’s assume, your basic pay is Rs. 10,000 per month and your basic rises 5% each year. The interest rate on EPF is credited annually at the end of financial year. Your contribution to EPF is 12% of basic pay, and the employer’s contribution to EPF is 3.67%. The rate of interest for the financial year 2012-13 is 8.6% per annum. The accounting period of PF is from March to February every year. The government credits the interest compounded on PF balance in April every year.
Years Monthly Basic + DA Yearly Basic + DA Employee Contribution Employer Contribution Total EPF Interest rate EPS Total amount
Year 1 10,000.00 1,20,000 14,400.00 7,908.00 22,308.00 8.60% 6,492.00 24,226.00
Year 2 10,500.00 1,26,000 15,120.00 8,628.00 23,748.00 8.60% 6,492.00 25,790.00
Year 3 11,025.00 1,32,300 15,876.00 9,384.00 25,260.00 8.60% 6,492.00 27,432.00
Interest on EPF:
The EPF interest rate is decided by the central government with the consultation of Central Board of Trustees. The EPF interest rate notification is available on the official website of EPF India on an annual basis. For FY 12-13, the interest calculated on EPF is 8.6%. The contribution is made to EPF on monthly basis, while interest is calculated at the end of the financial year.
At the beginning of the each fiscal, there would be an opening balance, the amount accumulated till then. Thus, for next fiscal, the new opening balance would be Old opening balance + monthly contribution throughout the year + interest (old opening balance + contribution).
For EPF, compound interest is paid on the amount standing to the credit of an employee as on 1 April every year. However, EPS being a pension scheme, interest is not applicable. Hence, no interest is earned on the amount accumulated in EPS.
EPF also has nomination facility. You can nominate your mother, father, spouse or children. However, you can’t nominate your brother or sister for EPF. The nominee will be contacted at the time of the death of the employee and handed over the EPF money. If a member has a family at the time of making a nomination, the nomination should be in favour of one or more persons belonging to his family.
Any nomination made by such member in favour of a person not belonging to his family shall be invalid. A fresh nomination should be made by the member on his marriage and any nomination made before such marriage will be deemed to be invalid.
A nomination is essential. The purpose of appointing a nominee is to have someone who is trustworthy and responsible to handle the nominator’s assets after his death.
The employer contribution is exempt from tax, while an employee’s contribution is taxable but eligible for deduction under Section 80C of Income-tax Act. The money which you initially invest in EPF, the interest you earn and, finally the money you withdraw after a specified period (5 years), are all exempt from income tax.
Transfer of EPF & EPS
You can apply for withdrawing EPF only if you are not employed for two months after leaving the previous job. It is recommended to transfer EPF account at the time of joining a new company instead of withdrawing it as EPF forms the debt part of your portfolio and gives good tax-free returns.
According to Suresh Sadagopan, Founder, Ladder7 Financial Advisories, employees changing their jobs should transfer their EPF corpus and do not withdraw it. EPF is currently offering 8.6% annually, which is not taxable. Hence, it is best to stay invested in. If you withdraw the EPF amount before completing five years of service with an employer, the corpus withdrawn is taxed. The amount is added to your salary income and taxed accordingly. On the other hand, if left untouched, it is completely tax-free.
For example, you have a PF account for the last five years and change your job and withdraw the PF amount, then all your previous years’ income gets recomputed from the very beginning and is taxable. This means the tax benefits which you had received for the last five years will get forfeited—and now your withdrawn PF amount is taxable. Further, the employer contribution and interest received will be added to your current income subject to relief under Section 89.
For EPS, if the service period is less than 10 years, you have an option to either withdraw your corpus or get it transferred by obtaining a ‘scheme certificate’ if there is a break in service. This way the number of years of service that you have put in gets transferred to the new account that you open in the new organisation.
For service below 10 years, you usually get 100% of your EPF & EPS amount invested. In case of EPF, you get the accumulated amount plus the interest (which is 8.6% for FY12-13). For EPS, you get your EPS amount invested over the years and the “withdrawal benefit”. The below table D shows the “withdrawal benefit” which an employee will get if he withdraws his EPS amount (from six months to nine years).
Return of contribution on exit from the employment Year of service Proportion of wages at exit
Note: The above table is based on a flat addition in benefit.
For instance: An employee exits from employment after four years of service his wage on exit is Rs. 5,000, (Return of contribution will be Rs. 5,000 x 3.99 of wages on exit) i.e., Rs.19,950. Once, an employee’s service period crosses 10 years, the withdrawal option ceases.
It is important to understand that – “To withdraw from EPS, an employee needs to contribute at least for six months. He has to fill-up Form No. 10 C (E.P.S) to claim withdrawal benefit. However, if the employee completes 10 years of the service, the withdrawal option ends. Thus, after 10 years of completion of the service, the employee cannot withdraw from his EPS.”
EPF withdrawal is not permitted if you are still working. But there are occasions when EPF withdrawal is allowed. You cannot withdraw it fully, but you can avail non-refundable advance for the purpose of your children’s higher education and their marriage. You can also withdraw for medical treatment for self or family, repaying your home loan, construction of a house, purchase of the flat, etc. You can avail the non-refundable advance, only after having completed minimum five years PF membership.
An employee can start receiving the pension under EPS only after rendering a minimum service of 10 years and attaining the age of 58 or 50 years. However, no pension is payable before the age of 50 years. Early pension—that is an employee receiving after completing 50 years of age but before 58 years—is subject to reducing factor @ 4% (from September 2008) for every year falling short of 58 years. In case of death/disablement, the above restriction is not applicable.
The pension amount is payable to the eligible subscriber till he survives. On the death of the employee, members of his family—whom he has nominated—are entitled to the pension.
Under EPS, the monthly pension is decided on the basis of ‘pensionable service’ and ‘pensionable salary’.
The formula to calculate pension is:
Monthly pension = (Pensionable salary X Pensionable service) ÷ 70
The amount of pension you get depends upon a fixed formula, which is average monthly salary of the last year of service multiplied by the number of years of service divided by 70. Remember your employer shows your salary as Rs. 6,500 for EPS, so the pension is calculated on a monthly salary of Rs. 6,500. So if you have worked for say 35 years, your monthly pension will come to Rs. 3250 [(Rs. 6,500 X 35 years)] ÷ 70 according to the formula. Thus, the maximum pension per month is subject to maximum of Rs. 3,250 per month.
The amount of pension is too less. If you invest Rs. 541 in a recurring deposit (compounded on monthly basis) at 8% interest rate per annum for 35 years, you would get Rs. 12,40,990 as maturity value. If this maturity amount is used to purchase an immediate annuity plan offering over 7% returns p.a., the monthly pension would be Rs. 7,239 which is much more than twice of Rs. 3,250.
You can invest more in PF
Have you heard of the possibility where you can invest more than the mandatory 12% into your PF account and get returns on it? Yes, you can always invest more than 12% of your basic salary in EPF which is called VPF (Voluntary Provident Fund). Apart from contributing the normal 12% of your basic pay, you may choose to put in an extra, say 10% of your salary into the same account. In this case, the excess amount will be invested in EPF and you will get the interest @ 8.6%.
EPF contribution is one of the best and least risky ways for salaried people to build their retirement nest. But remember, your employer’s contribution will be limited to the amounts payable on a monthly pay of Rs. 6,500 including basic + DA. It is not compulsory to the employer, to match your voluntary contribution.