You must be well familiar with the term EPF popularly called “Employee Provident Fund”. The Employee Provident Fund is managed by an organization called Employees Provident Fund Organization (EPFO).
What is EPF?
If you earn a salary, an amount of 12% is compulsorily deducted from your salary. This amount is contributed to an account in your name, called the employee provident fund. Your employer makes an equal contribution (contributes the same amount as you have contributed), to this account. This account is maintained by the EPFO.
A small portion of your employer’s contribution, goes to an account maintained in your name, called employee pension Scheme (EPS). Only your employer makes a contribution to the EPS.
Compulsory contribution of 12% of your salary to an account called employee provident fund.Your employer makes an equal contribution. A small portion of your employers contribution goes to an account called the EPS. The money in this account gives you a pension after retirement.
Interest on EPF
You get 8.75% interest per year on the money in your employee provident fund.
Tax benefits of EPF
Your investment in the EPF enjoys “EEE” benefits. “EEE” means exempt exempt exempt. The amount you contribute to the EPF enjoys a deduction under Section 80 C of the income tax act up to INR 1.5 Lakhs a year.
Out of the amount you contribute (employee’s contribution), a maximum amount of INR 1.5 Lakhs a year can be availed as a deduction under Section 80 C of the income tax act. This reduces your taxable income.
The money accumulates with time (increases as you get interest on this amount), and no tax is charged on this amount. The money you withdraw at the time of retirement is tax free.
Remember: The contributions you make to the EPF along with the interest that accumulates on it, is tax free at withdrawal, only if the money is withdrawn after 5 years of continuous service.
When you open an EPF account and make your contributions, you are assigned a UAN (Universal Account Number). When you change your job, your account can easily be transferred, because your UAN number remains constant.
Withdraw money from your EPF
Earlier you could withdraw 100% of the money accumulated in the EPF when you changed your job. Now if you make a pre mature withdrawal (a withdrawal before retirement), you get only 75% of the money accumulated in the EPF.
The purpose of the Government forcing you to invest in the EPF, is to make sure that you have money for your retirement. The Government discourages you to make a pre-mature withdrawal (withdraw money before your retirement).
You can withdraw only 75% of the money accumulated in your EPF even for a medical emergency, buying a house, children’s higher education, marriage or if you are unemployed for 2 months.
India does not have pension and social security schemes, like Western Countries.EPF makes up for this shortcoming.
Where does the EPFO invest your money?
The EPFO invests about 65% of your money in Government securities. An investment in Government securities is risk free, as the investment is guaranteed by the Government of India.
Your Principal (contributions made in the EPF) + Interest (Amount earned on the money invested in the EPF), is guaranteed and safe.
The remaining amount is invested in public sector and private sector bonds. The investment made in the private sector bonds is only 5%.
The EPFO charges a fee of 0.00005% to manage your money which is deducted from the fund itself.
What if EPFO invests your money in stocks?
The EPFO has recently shifted its investments to the stock market. This is done to give you a higher return than the mere interest of 8.75% a year.
To minimize risk, EPFO will not directly invest your money in stocks. The EPFO will invest your money in ETF’s popularly called exchange traded funds.
An ETF is a basket of securities, that tracks stock prices of Companies that comprise of an underlying index, which is traded on the stock exchange. This index may be BSE Sensex, CNX Nifty, or even the CPSE (Central Public Sector Enterprise).CPSE consists of PSU stocks which are traded on the National Stock Exchange, (NSE).The EPFO has currently shortlisted two schemes of the SBI mutual fund, namely SBI ETF Nifty and the SBI Sensex ETF. An ETF is passively managed. (It just tracks the index say the CPSE and gives returns in line with the index).
The manager of the ETF does not have any major financial decisions to make, as the ETF just tracks an index. This means he does not have to take any risks. So he cannot charge too high an amount to manage the ETF. This means the expense ratio of the ETF is low.
Expense ratio is the total charge you pay for an investment in the ETF.SBI mutual Fund has agreed to charge the EPFO, only 0.07% as an expense ratio. You will have to bear this expense ratio.
EPFO invests in stocks-Is it good?
The labor ministry has allowed the EPFO to invest only 5-15% of the EPF money in equities, even with the ETF route. EPFO has decided to go slow on its investments in equities, at just 5% of the incremental corpus in ETF’s.
This is too small an amount to judge the performance of the EPFO in equities. A higher proportion in equities, 10-15%, will mean you get better returns.
EPFO will continue to offer interest for the time being, just as it declares at the start of each year. This is a rate at which your money will compound for the year. The rates which will be offered in the future will take an investment in equities also into consideration.
An investment in stocks/equities which is made for at least 3 years, is known to give good returns. EPFO will invest your money for a much longer time. If the investments do well, a part of the money is stored to give you a good return when the market is under performing.
It is too early to make a decision if an investment by the EPFO in stocks is good or bad. However going by the track record of ETF’s they have given a good return over the past few years.
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