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Don't dip into your PF earlier than necessary

February 4, 2009

The Provident Fund is your retirement cushion. Borrowing from it to fund your current expenses and investment goals can do more harm than good. Here are five reasons why you should not dip into your nest egg earlier.

I want to buy a second house. Should I withdraw money from my Provident Fund or take a bigger home loan?

The interest rates on home loans have come down, but are still high at around 10%. In comparison, the balance in your Provident Fund (PF) account earns only 8.5%. So common sense says that withdrawing from the PF account is less expensive than taking a home loan. Despite the arithmetic, dipping into your PF is not a good idea and you should go for a bigger home loan. Here are five reasons why you should not touch your PF account:

1. The PF is your cushion

Withdraw from your PF only in dire circumstances, and that too, after you have exhausted all potential sources of funding. If you take out money from the PF to buy assets or pay higher interest loans, you won’t have the cushion when you face a real financial emergency. This money is meant for a rainy day, not for everyday use.

Value of corpus (in Rs lakh)
Deposit (per month) 5 yrs 10 yrs 15 yrs 20 yrs 25 yrs
Rs 2,0001.493.787.2912.6320.79
Rs 4,0002.997.5814.5725.2641.57
Rs 6,0004.4911.3721.8637.8962.36
Rs 8,0005.9915.1629.1550.5683.15
Assuming annual compounded growth of 8.5%

2. You lose the power of compounding

Don’t be tempted to compromise on your future to finance your investment plans today. At 8.5%, the balance in your PF account doubles in a little over eight years. Withdraw it, and it loses the power of compounding. This also goes against the basic principal of long-term investing. If your PF is untouched, a sound retirement nest egg will be waiting for you in the future.

3. You may not earn more

Withdrawing from one avenue to invest in another makes sense if your returns are higher. But you are using the money to invest in real estate, a sector that is showing clear signs of a slowdown. Real estate prices are not expected to shoot up as they had done in the past four to five years. So your investment may not earn the kind of returns you are expecting. Worse, in some cases, you may even lose money if the property prices go down. It is wiser not to break a safe and steady investment to enter a risky avenue.

4. You are investing beyond your means

When you need to borrow from your savings, it is a warning that you are living (or investing) beyond your means. It would have been fine if you were buying this house for occupying it yourself. But this is your second house, which means you are probably speculating.

5. Withdrawals are rarely repaid

When you withdraw from a PF, you are given two options: to refund it or not to refund it. Ideally, you should replenish the account after you tide over the financial crunch. But few people have the financial discipline to do so and most of the withdrawals end up being non-refundable.
Even if you are confident that you can replenish your PF account in a few years, it is a better idea to go for a bigger home loan. This is because it will give you income-tax benefits. Amounts up to Rs 1.5 lakh paid as interest on a home loan are eligible for deduction in a year under Section 24(b). This helps bring down the effective cost of borrowing.

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