How to make the most of your investments in EPF and NPS
NEW DELHI: it can be complicated. First, inflation is eating your savings. Then there are bankers and unscrupulous agents, who sell poorly unsuitable products. Add to this the tendency to invest in traditional avenues such as gold and real estate and you will have all the ingredients for an unstable future.
However, the positive side is the two dedicated retirement vehicles: the humble EPF (Employee Pension Fund) and the most recent NPS (). Both are evolving: they add new features, grant more options and introduce flexibility in investments and withdrawals.
Here, we focus on the changing retirement landscape and how you can make the most of these two instruments to ensure your golden years.
Employee Pension Fund (EPF)
For salaried persons, each month, 12% of their basic salary, together with an equivalent contribution from their employer, flows to the EPF account. Of the employer's contribution, 8.33% goes to a pension vehicle: the EPS. The contribution is not only eligible for tax benefits under section 80C, but both the interest earned and the money received in retirement are tax free.
The EPF ensures that their contributions continue to increase steadily. However, to really benefit from the EPF, you should consider the following points:
Keep the account until retirement
The partial early withdrawal of EPF is now allowed for a child's marriage, higher education and down payment of a house, subject to conditions. Members can withdraw the total amount if they remain unemployed for more than two months. However, if the body is partially removed in the accumulation phase, it takes away the compound benefits.
The VPF is an extension of the EPF that allows you to invest beyond the 12% threshold while providing the same tax benefits and profitability. Although the PPF has an investment limit of Rs 1.5 lakh per year, there is no such restriction in VPF. In addition, unlike PPF returns that fluctuate in line with the 10-year government bond yield, the VPF interest rate is the same as that of the EPF. The current interest rate of 8.65% is much higher than that of 7.9% of PPF.
When changing jobs, do not withdraw, but transfer your current EPF balance to the new employer. There are several drawbacks if the amount is not transferred or withdrawn and remains inactive. First, it could increase your tax liability. The interest accrued on the non-operating account becomes taxable, even if you do not withdraw money from the account. If the balance of the EPF is not transferred, it also means that previous periods of employment will not be counted for pension eligibility at the time of retirement under EPS. One is eligible for pension benefits once they have completed 10 years of service.
National Pension Plan (NPS)
In recent years, this dedicated pension offer has evolved to be more tax-efficient, offering more flexibility and options. The NPS now allows the deployment of up to 75% of the corpus in shares, which gives it the potential for faster long-term wealth creation. On the other hand, the EPF currently invests only 15% of the incremental corpus in shares. This is how you can make the most of the NPS:
Get multiple tax benefits
While capital gains from capital funds now face a 10% tax above the threshold of Rs 1 lakh, the taxation of NPS is gradually moving in the opposite direction. Previously, only 40% of the 60% of the accumulated corpus allowed to be withdrawn as a lump sum at the time of retirement was tax free. The remaining 20% was taxed at normal rates.
Now, all 60% is tax free. The balance of 40% has yet to be mandatory in an annuity, which is subject to taxes. NPS subscribers can claim an additional deduction of up to Rs 50,000 under Section 80CCD (1B). In the 30% tax bracket, this means additional tax savings of Rs 15,600. Together, subscribers can claim a deduction of up to Rs 2 lakh for contributions to NPS. Subscribers can also further reduce tax liability if their employer places up to 10% of their base in the NPS under section 80CCD (2).
Beyond tax savings
Do not invest in NPS only for tax benefits. For example, reserving Rs 50,000 per year in NPS for the additional tax benefit may not add much to your retirement corpus. Setting a limit creates an artificial roof for your savings. In addition, it will deprive you of adequate pension benefits. People with an already reinforced retirement portfolio may not need to reserve a large sum in NPS. You can end up blocking money unnecessarily for a long time just for tax reasons.
Use the switches judiciously
The NPS allows active fund management to potentially deliver market profits to the subscriber. However, with active investment comes the element of prejudice and human judgment. It is critical that NPS subscribers choose the fund manager carefully and continue to monitor performance. If the selected fund manager lags behind others, you can switch to another fund manager. NPS now allows two changes in one year, without any fiscal impact. However, subscribers should not abuse this flexibility by constantly changing fund managers.
Opt for an active option
The NPS offers subscribers the option of two modes of investment: active option and automatic option. Under Active Option, you can choose your own combination of assets and decide the division between stocks, corporate bonds and government bonds.
Otherwise, you can opt for life cycle funds where the combination of assets automatically changes as the individual ages. Three life cycle funds: aggressive, moderate and conservative, serve investors with different risk appetites. The gradual decrease in exposure to equity protects the corpus against volatility as retirement approaches.
However, automatic choice may be restrictive since this moderation in exposure to shares begins too soon. Whatever your risk profile, exposure begins to decrease after 36 years. Investors who have a fair knowledge of the market should opt for the active choice model.