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Some facts about EPF that impact your retirement savings

Some facts about EPF that impact your retirement savings

The Employee Provident Fund corpus could account for a substantial part of your retirement corpus. Let's look at the little-known facts about EPF that might impact your retirement savings.

It's a shock that many people are familiar with. Most believe that employers are bound to add an amount equal to their own contribution to the Employee Provident Fund (EPF ) account. But a lot of companies deposit just 10-12 per cent of the amount contributed by their employees.

The shock is understandable, but not justified. Under the EPF Act, employers can choose to contribute just 12 per cent of Rs 6,500 a month, irrespective of the actual salary.

There are many such important facts about the EPF account, which accounts for a big chunk of long-term savings, which you may not be aware of. Here we talk about a few.

Calculating contribution:
Your contribution is at least 12 per cent of your salary, including basic, dearness allowance (including cash value of any food concession) and retention allowance. House rent allowance, overtime, bonus and commission are excluded.

The definition of basic wage has been a subject of debate for quite some time. "There have been divergent rulings on the interpretation of the term 'basic wage', with Madras and Madhya Pradesh high courts covering all allowances within the definition and the Punjab and Haryana High Court taking a contrary view," says Divya Baweja, senior director, Deloitte Touche Tohmatsu India.

Employers are supposed to make a matching contribution. But they are not legally bound to do that. In most cases where employers make a matching contribution, the amount is included in the gross salary.

Fund management:
The money goes into a fund managed by the Employees' Provident Fund Organisation or EPFO , which comes under the labour ministry. The government allows employers to manage own provident fund schemes, provided they adhere to certain conditions.

"There are 31 conditions for setting up a private provident fund. The main are that the employer's contribution should not be less favourable than in the statutor schemes and the annual rate of interest should be at least what the EPF pays its subscribers," says Parizad Sirwalla, partner, KPMG India.

The private trusts have to seek separate approval from the Income Tax Department for tax benefits on employees' contribution to the fund.

Where your money is invested: Only in fixed-income securities. Investment in equities is not allowed. The securities where your money can be invested are central and state government bonds, bonds issued by public sector companies, fixed deposits of public sector banks and mutual fund schemes that invest in government securities.

Rate of interest:
It is announced every year according to the central government's recommendations in consultation with the board of trustees of the EPFO. In 2011-12, the EPFO announced 8.25 per cent interest on the monthly running balance. In 2010-11, the rate was 9.5 per cent, while in the preceding five years it was 8.5 per cent.

If your account remains inactive (no contribution is made) for three years, the money will cease to earn any interest.

Tax benefits:
The employee contribution up to Rs 1 lakh is deducted from the taxable income under Section 80 (C) of the I-T Act. The employer's contribution is also exempt from tax. The interest earned is also tax-free.

The rules are slightly different in case of private trusts. The employer's contribution is tax-exempt only up to 12 per cent of basic pay. Also, only the interest earned up to the rate offered by the EPFO to its subscribers is tax-free. Anything over and above that is taxed.

Withdrawals and advances:
You can withdraw money only if you have been a member for at least five years and that too for the following purposes.

1. For purchase or construction of a house/flat or buying a residential plot. The amount is the least of 36 months' basic wages and dearness allowance or your contribution, together with the employer's contribution with interest, or cost of construction

2. For repayment of loan from a state government, registered co-operative society, state housing board, nationalised bank or public financial institution. The amount that can be withdrawn is the same as in the above case.

3. For marriage or higher education of children. In such a case, you should have been a member for at least seven years and the account should have a balance of at least Rs 1,000. The loan cannot exceed 50 per cent of your contribution with interest.

4. For treatment of a family member in case of hospitalisation lasting a month or more, diseases such as tuberculosis, leprosy, paralysis, cancer, mental derangement and heart ailment, or a major surgery. The loan amount cannot exceed six months' basic wage and dearness allowance or your own contribution with interest, whichever is lower.

5. A physically challenged person can avail of a non-refundable advance for purchasing equipment "required to minimise the hardship on account of the handicap" after furnishing a certificate from a medical practitioner. The amount cannot exceed six months' basic wage and dearness allowance or own contribution with interest or the cost of the equipment.

6. You can withdraw 90 per cent money one year before retirement. Other conditions for withdrawal are migration from India for settling/working abroad and termination of service.

A person leaving the organisation can go for full withdrawal. However, if the account is less than five years old, doing do will have tax implications in the following ways:

>> Employee's contribution, on which he has claimed deduction under Section 80C of the I-T Act, will be taxable as income in the year of withdrawal.

>> Employer's contribution up to 12 per cent basic salary will be taxable as Salary Income.

>> The accumulated interest will be taxable in the hands of the employee as Income from Other Sources.

"The balance withdrawn is, however, exempt if the service has been terminated before five years due to ill-health or reasons beyond the employee's control. It is also exempt if the balance is transferred to his individual account in any recognised provident fund maintained by the new employer," says Divya Baweja, senior director, Deloitte Touche Tohmatsu India.

Withdrawal or transfer:
As mentioned earlier, if the account is less than five years old, all tax benefits availed on it will be reversed if the money is withdrawn. In such a case, it is better to transfer the money to the new account. It will ensure that you save tax as well as not spend the amount that is best kept for your post-retirement years.

The Employee Provident Fund corpus could account for a substantial part of your retirement corpus, provided you allow it to grow over the years and not spend it on frivolous things by withdrawing it midway.