Saturday, 17 November 2018

A Guide to Voluntary Provident Fund

Fixed income investors always look for products that offer better return, exempted from tax and are less risky in nature. Consider Bank FD's which offer assured return but the interest is taxable and post tax return is much lower than expected (depending on the tax slab you fall in). Voluntary Provident Fund (VPF) is one such instrument, available only to salaried individuals, that offers attractive rate of interest in comparison to other instruments falling in the same category and is tax friendly at the same time.


A Guide to Voluntary Provident Fund


Overview

  • Every month a salaried individual and the employer contributes 12% of Basic Salary and Dearness Allowance (DA) into the individuals Employee Provident Fund (EPF). VPF is an additional contribution (besides the mandatory 12%) made by the employee into his EPF account. The additional contribution is subject to a maximum of 100% of your basic salary and DA.
  • Generally fixed income investors park their money in the popular Public Provident Fund (PPF) which at present offers 8% interest (as on Oct 1, 2018). However, EPF is offering 8.55% interest (FY 17-18) and the features are similar to PPF with respect to tax treatment. In other words, by opting for VPF an individual can earn 8.55% interest and can also claim deduction under Section 80C.
  • One key point to note is that since the additional contribution is an individual own willingness in VPF, employers do not contribute the matching amount in the individuals account.
Comparison PF, EPF and VPF

How to Start or Exit VPF
  • In order to start VPF, an employee needs to give his confirmation to the employer and specify a fixed amount or percentage of pay to be contributed to his EPF account
  • Many companies usually initiate VPF at the beginning of a financial year and employees should take a note of this. Some companies even open a quarterly window to take such requests, which means one can not opt for VPF whenever he/she wishes
  • Similarly, if one wishes to exit VPF, an employee should submit the request during the specified time as per a company's schedule

Pros of Opting VPF

  • Higher rate of Interest than other Debt Investment Options: By offering 8.55% interest, VPF easily overshadows other debt investment options such as PPF and NSC's (National Saving Certificate). Not only for the current year, VPF has consistently given better returns in comparison to PPF and NSC's in the last 5 years.
  • Tax Benefits: Investment made under VPF can be claimed to save tax under section 80C. Moreover, the interest earned and withdrawal is also non-taxable. Please note interest is taxable if one withdraws within 5 years of making the first contribution.
  • Easy to Start: In order to start VPF, one does not have to go to any institution such as Banks or Post Office, and just have to inform the employer at the right time. Your existing EPF account will be used for additional contributions

Cons of Opting VPF

  • Lock in Period: Since the aim of EPF and VPF is to support people during retirement, the lock in period is very high. An investor should never consider this instrument to achieve short term goals. You can withdraw your corpus after retirement or if you are unemployed for a minimum 60 days. Partial withdrawals are available but only under special cases such as marriage of children or medical emergency.
  • Limited Accessibility and can not be Started Anytime: If you are salaried and are a member of EPF, then only you can opt for VPF. It is not available to every individual. Also, it can not be started or exited as per an individual wish and varies from company to company.

Verdict

VPF is one of the most underrated investment avenues that is most suitable for risk averse investors whose investment horizon is long and who prefer fixed income. In other words, it is ideal for those people who want to save for their retirement by taking minimum risk. It is by far the most superior debt instrument offering assured returns and is tax friendly at the same time. Corporate and Bank FD's may offer higher interest but are taxable. However, if you are a long term investor with high risk appetite than I would suggest to go for equities or Mutual Funds for better returns.