Provident funds come in two kinds. The first is the Employees’ Provident Fund or EPF and the second is the Public Provident Fund or PPF. They are as embedded in our cultural memory as Bajaj Scooters and Mummyji’s pakoras. They are the retirement options that our parents have invested in and still invest in. Let’s take a close look at them and see how they stack up against mutual funds.
Employees’ Provident Fund or EPF
The EPF (popularly known as just ‘PF’) is a mandatory salary deduction for some employers and many others voluntarily offer it. Typically an employer cuts about 12% of your salary and adds another 12% from its own funds to pay into your EPF. Though the employer’s contribution can seem like a freebie, it is part of your ‘CTC” or cost-to-company.
In most cases, you don’t have a choice about the EPF. However, it is useful to know what kind of returns it delivers. Also, your EPF contribution counts towards the annual deduction under Section 80C.
The EPF interest is completely tax-free. You can withdraw your EPF corpus on specified grounds (eg: home purchase) or when you become unemployed or retire at the age of 58.
Public Provident Fund or PPF
The PPF or Public Provident Fund is a voluntary government-run savings scheme. You can contribute up to Rs 1.5 lakh to it per annum and this contribution is also eligible for education under Section 80C. The PPF rate used to be declared annually but is now set quarterly (currently 7.6%).
The PPF interest is completely tax-free. You can withdraw your PPF deposits after 15 years of opening the account. You can also make partial withdrawals after 7 years on specified grounds
Here’s a snapshot of Provident Fund returns over the past decade:
Source: National Savings Institute, EPFO; Data for 2011 and 2017 are weighted averages due to rate changes during the year.
To explain it further, Rs 1 lakh invested in the EPF in 2007 would be worth Rs 2.30 lakh* now. Similarly, Rs 1 lakh invested in the PPF in 2007 would be Rs 2.22 lakh* now.
Equity funds are the best alternative to EPF and PPF since these are held over long time periods (about 5 years and above). More specifically, tax planning or ELSS funds which are eligible for tax deduction up to Rs 1.5 lakh under Section 80C are direct competitors.
For instance, Rs 1 lakh invested in HDFC Equity Fund (which was around in 2007) would have grown to Rs 4.47 lakh over the same time period. The same amount in one of the largest tax-saving funds, Reliance Tax-saver would have grown to Rs 4.97 lakh.
It is easy to pick a ‘winning fund’ in hindsight preventing this from becoming an open-and-shut case. However, the outperformance by mutual funds on average has grown stronger in recent years. Tax-planning funds have delivered an annualised 19% over the past five years and multi-cap funds have not remained far behind with 18.5% (all returns pre-tax).
In the Budget 2018, which will become an act of Parliament with effect from April 1, 2018, the returns on equity funds will attract 10% long-term capital gains tax. This is applicable for equity fund units held for more than a year and only if the total long-term equity returns exceed Rs 1 lakh in a year.
It is important to remember that mutual funds are volatile and can deliver negative returns too. However, if you can stomach the risk and stay with these funds for the long term, the rewards as the numbers above show, can be ‘yuge’ (as Donald Trump would say).
Note: Returns calculated from funds NAVs as on 3rd November 2017. Source, Value Research.