The Employees Provident Fund Organisation (EPFO) has recently raised the interest rate on Employees Provident Fund (EPF) to 8.65 per cent for the financial year 2018-2019 from 8.55 per cent for the year 2017-2018. In a scenario where interest rates are on a downhill, this kind of guaranteed tax-free return is attractive and will make the salaried class happy, most of whom contribute to EPF on a monthly basis for their retirement. But, is EPF really the best retirement saving option? As EPFO invests predominantly in debt instrument, are you losing out on the potential return that equities can deliver over long-term. How does EPF fare against National Pension Scheme (NPS), which has recently become more tax efficient?
Let's compare the two options on various parameters and decide whether you should go for EPF or NPS, or both.
Contribution: An employee has to contribute 12 per cent of basic wages towards EPF. A matching contribution is made by the employer. From the employer's contribution, 8.33 per cent (up to Rs 1,250) goes towards employee pension scheme (EPS). You can invest in EPF only through employer. Most of the salaried people contribute towards EPF. However, it is not mandatory for those earning a basic salary above Rs 15,000 per month.
NPS is voluntary defined-contribution scheme (only for non-government employees) under which an employee has to contribute 10 per cent of the salary plus dearness allowance as mandatory monthly contribution and a matching contribution can be made by the employer. You can open an NPS account on your own also.
Return: The Central Board of trustees is the apex decision-making body of EPFO, which fixes the interest rates to be offered on EPF for the year depending on the earnings. The proposal then goes to the Finance Ministry for approval after which the interest is credited to the subscriber's account. EPF has given an average interest of 8.68 per cent over the past five years.
NPS is market-linked product, where the performance of your portfolio will depend on the fund you choose and performance of equity and debt markets. There are eight fund managers to choose from. It will also depend on allocation to different asset classes such as debt, equity, and corporate bonds. The Tier-1 equity funds have delivered an average return of 13 per cent over the past five years, corporate debt funds have delivered 10 per cent while government securities have delivered 11 per cent as on January 31, 2019.
Safety: Returns from EPF are guaranteed and backed by government. So, there is no question of loss of capital. However, as stated earlier, NPS returns are market-linked and nothing is guaranteed. Therefore, over short-term, NPS may face some loss of capital if equity markets are not doing well but over long-term the chances of equity delivering losses are low. Also, the debt portfolio investment in case of NPS is subject to the interest rate risk and credit risk.
Asset allocation: EPFO mainly invests in debt securities and has started taking exposure in equities, which has been raised to 15 per cent recently. While under NPS, the subscriber has an option to go up to 75 per cent in equity until 50 years of age, under NPS, the subscriber has the option to choose the fund manager as well as the allocation they want in different asset classes --equity, corporate debt, government securities and alternative assets (within the prescribed limits). "This flexibility to take higher exposure to equity can allow NPS investors to accumulate large corpus over a time horizon. However, if an investor is approaching his retirement age, he might prefer fixed returns of EPF," says Lovaii Navlakhi, MD and CEO, International Money Matters
EPF falls under the exempt exempt and exempt (EEE) category that is the investments made upto Rs 1.50 lakh under Section 80C, the interest accrued and the accumulation on withdrawal are all tax free.
NPS has recently received the much-awaited EEE tax status, thus bringing it at par with EPF. Now, if you invest in NPS, the investments up to Rs 1.5 lakh under section 80C and Rs 50,000 under Sec 80CCD (1B) are tax exempt. Employee can also claim a tax deduction on the employer's contribution up to 10 per cent of the basic salary plus dearness allowances. There is no upper limit on the amount of deduction.
Should you go for EPF, NPS or Both?
EPF and NPS are both good options. EPF offers guaranteed returns and is debt-heavy investment, while NPS is a low-cost product, which gives the flexibility to have higher allocation to equity for building a retirement corpus.
For most of the salaried people, not investing or opting out of EPF is not possible as it is part of salary. If you want to invest in NPS you can open an account on your own through point-of-presence (PoP).
Basis the risk profile, you can decide on the allocation between NPS and EPF.
"If one should invest in EPF or NPS, it differs from client to client based on their age and the years left for retirement. If a client is aged below 40 years and has many years before retirement, a higher exposure to equity in NPS vs EPF makes more sense considering a higher exposure to equity could help accumulate a larger corpus by retirement. However, if you are above 40 years, you might want to divide between NPS and EPF. If you are close to retirement then higher allocation to EPF helps given assured returns of EPF," says Navlakhi of International Money Matters.