Do you know that from the next financial year, any interest you earn on your employee’s provident fund (EPF), on a contribution above Rs 2,50,000 lakh a year, will get taxed at the prevailing rates? This was announced earlier in February 2021 and will be applicable for contributions made from April 2021 onwards.
Currently, the EPFO pays 8.5% a year on the deposits made by employees where the company they work for gives them a choice to opt for a statutory EPF contribution. If you are in the highest tax bracket of the personal income tax ladder, you will end up paying tax at anywhere between 35.9%-42.5% each year on the excess interest earned on your EPF contribution every year.
There are those who had increased their contribution to EPF on a voluntary basis to get the advantage of the earlier nontaxable, guaranteed, high-interest payout, but is it still worth your while to continue such voluntary contributions or should you switch?
However, if you already have a suitable fixed income allocation in place and have accumulated assets to take care of the stable return part of your portfolio, then any voluntary contribution that is currently going towards EPF can be considered for long term equity.
Your asset allocation mix
Your EPF contribution adds fixed income exposure to your investment portfolio. The return is guaranteed and most people keep it invested till they retire. If you switch this to equity assets, the risk in your portfolio will increase. You will have to prepare yourself accordingly.
However, if you already have a suitable fixed income allocation in place and have accumulated assets to take care of the stable return part of your portfolio, then any voluntary contribution that is currently going towards EPF can be considered for long term equity. EPF is long term money and for 10–15-year kind of allocation equity returns are most tax-efficient and inflation positive.
Be mindful of your asset allocation balance and make this change only from your voluntary contribution and if your fixed income allocation is covered through other investment avenues.
Higher tax outgo calls for more efficient investing
Those who have opted for EPF facility may not be able to change or reduce their contribution as it is linked to their basic salary. Basic salary is also the foundation for other benefits like housing rent allowance.
This means you will likely be paying a higher tax on your income now; this also means a reduction in forced savings by that amount. While there is little you can do about this forced outgo, you might want to compensate for it by adjusting and adding more to your long-term equity basket.
It is counter-intuitive to save and invest even more given that you have a higher tax outgo, but setting up a systematic investment plan in an equity mutual fund for an amount close to the additional tax you pay, will help you retain the expected level of the corpus at retirement. The additional tax will eat into this expected corpus and you need to think of how you can fill the gap.
You may have no choice but to leave your EPF contributions as is for now and while so far it made sense to rely on it for retirement savings, things are changing. Not only will your excess interest be taxed from April 2021, but also, given the low-interest rate trend in the economy coupled with the Government’s rising expenditure bill, there is a chance that the guaranteed return offered may get lowered too.
Keeping these changes in mind, it is wise to start making your long-term portfolio more efficient as a retirement tool. You may now have to seriously consider bumping up your equity allocation to enhance your retirement kitty.