How good is an 8.25% interest rate for your retirement corpus? Here's a take

The central board of trustees of Employees Provident Fund Organisation (EPFO), headed by the labour and employment minister Bhupender Yadav, gave its go ahead at the 235th board meeting to a three-year high interest rate of 8.25% on Employees’ Provident Fund (EPF) deposits for 2023-24. 

The Labour and Employment Ministry said the Board has recommended a distribution of “historic income amount of Rs 1,07,000 crore” to EPF members’ accounts on a total principal amount of about Rs 13.0 lakh crore in 2023-24. This compares with EPF’s income of Rs 91,151.6 crore and Rs 11.0 lakh crore principal amount in the financial year 2022-23.

The decision to provide an 8.25% interest rate for 2023-24 was made by the EPFO's apex decision-making body, the Central Board of Trustees (CBT), during its meeting on February 10, 2024 a move that is anticipated to cheer up over 6.9 crore active EPFO subscribers.

In 2023, the Employees' Provident Fund Organisation (EPFO) had increased the interest rate on EPF marginally to 8.15% from 8.1% in 2022. Going back in past, the interest rate of previous 30 years i.e. during 1981-2021 has been always upward of 8.5% except in 2012 where it was tad lower to 8.25%. During 1989-2000 period, EPFO interest rates delivered a consistent 12% return giving a significant boost to common man retirement kitty. 

In the absence of any other strong social security scheme in India, Provident Fund so far, has played an important if not critical role in providing towards the retirement planning however, withdrawals during job switch, partial withdrawals for specific purposes etc during the service are some of the reasons it has yet, not become the most effective retirement fund provider for the working class. 

In this backdrop let’s evaluate whether 8.25% interest rate announced is lucrative and how does it compare with other instruments available.

If you compare the average return of 8.6% on PF between 2011-23 against same period average inflation of 6.1%, you feel fairly pleased about your savings in PF having grown in real terms. Over last 10-12 years EPF returns have always outdone the inflation rate except for year 2012-13 wherein inflation was higher than the PF interest rates. 

Prima facie, Equity asset class has outperformed PF returns, in almost every time period however surprisingly, NPS’s (National Pension Scheme) return in G “asset class” which invests in Government Bonds and related instruments has shown a higher return of approximately 10% both in One and Ten years’ period. 
It’s important to remind that NPS came into existence under the PFRDA Act, 2013 as Pension Fund Regulatory and Development Authority (PFRDA) as regulator. As EPFO is allowed to invest in Equity and related instruments upto 15% of its fund and with close to 2 lakh crore in ETF and rest in Bonds, EPF’s return of 8.25% for sure looks surely subdued. 

This becomes more noticeable in light of a particularly thriving 2023 for equity market and on the other hand higher return from NPS.

The EPF withdrawal is exempt from tax when an employee withdraws the amount after 5 years of continuous service. TDS is deducted @ 10% on EPF balance if withdrawn before 5 years of service, and the amount is above Rs 50,000. In case of NPS, while full withdrawal is free however at least 40% of the amount needs to be invested in annuity whereas in case of PF, 100% withdrawal is permissible. 

Considering the 10% & 5% tax on long term and short term capital gain and applicable Income Tax slab rates on others, no tax on withdrawal combined 
with flexibility in 100% take out, EPF gains severely against all other products.

Effective 1 April 2022, a change was brought in by current Finance Minister Nirmala Sitharaman wherein any interest on an employee’s contribution to EPF upto INR 2.5 lakhs per year is tax-free and any interest earned on a contribution over and above INR 2.5 lakhs is taxable in the hands of the employees. The threshold of INR 2.5 lakhs is increased to INR 5 lakhs in case the employer is not contributing towards EPF.

This has become a deterrent for obvious reasons and taken the sheen of EPF in becoming a helpful retirement tool in turn impacting voluntary PF contribution and naturally the higher EPF contribution. Since it impacts a small segment of PF contributors, it is also an insignificant source of tax for the state ex chequer. On the other hand, for retirees to lead a decent post retirement life, contribution of a respectable amount from EPF will make it more attractive. 

Look at an example – A young executive starting at 24 years of age with a salary of Rs 10.0 Lakh per annum can accumulate a total wealth of 1.7 crore only with equal contribution from his employer after 36 years at retirement which may not be adequate. (For this calculation annual salary growth of 5% and PF return of 8.5% is considered) In this case employee will also touch a ceiling of 2.5 lakh contribution in 33rd/34th year and will end up paying tax on interest which may reduce the overall accumulation.

It’s therefore imperative for the policy makers to strengthen the effort to encourage savings for retirement so that elderly can lead a respectful life and in that endeavour any measures which can prove counterproductive must be avoidable.

Under the guidelines related to equities and related Investments, EPFO can invest in shares of companies listed on BSE or NSE which have a market capitalisation of Rs 5000 crore or more. Investment can also be made in mutual funds which have a minimum of 65 per cent of their investment in BSE or NSE listed equity. Another option is Exchanged-Traded Funds (ETFs)/Index Funds that replicate the portfolio of either the BSE Sensex Index or the NSE Nifty 
50 Index. 

ETFs issued by SEBI-regulated mutual funds constructed specifically for disinvestment of shareholding of the Government of India in body corporates can also be used for option. It’s important to highlight that EPFO does not invest directly in individual stocks including stocks of any blue-chip company. EPFO invests in Equity markets through ETFs replicating BSE-SENSEX and NIFTY-50 indices.

As explained above, EPFO is allowed to invest in Equity and elated instruments in the range of 5-15% and rest in govt. bonds. Considering the purpose of Employee Provident Fund, it is only appropriate to keep a conservative approach of fund management and hence EPFO’s current approach of keeping approximately 9% in ETFs at best could be improved towards the maximum ceiling i.e. 15% to boost return, however any further riskier investment is 
avoidable. 

Total corpus of funds managed by EPFO as of Mar 31, 2022 was Rs 18.3 lakh crore, out of which over 91.3% investment is in Debt instruments with the remaining 8.7% in ETFs. The retirement body has invested a total of over ₹2.01 lakh crore in ETFs since 2018-19 till July 2023. A deeper breakdown of returns on both the investments for 2024 (12.5% on ETFs and 8.25% on Govt Bond) tells us that the return surely should have been upward of 8.5% if not 
lesser. A higher return can have a magical impact and aid significantly to the compounding effect of PF accumulation for more than 6.9 crore contributors.

The writer is a Human resource professional. Views are personal