Thumbs downThe proposal by the Government’s Labour & Employment Ministry to reduce worker’s contribution to the Employees’ Provident Fund (EPF) to improve in-hand salaries is virtually a double-edged sword. At present, a minimum 12% of basic pay is deducted from your salary once as employer’s share and second as your (employee) share towards the EPF savings. By reducing the worker’s contribution to below 12%, more money will definitely come in the hands of workers, but the amount of savings getting a solid 8.65% return (EPF interest rate on deposits) will also drop.

This means there will be less savings and consequently, you will also lose out on earning a good rate of return. In all likelihood, the extra in-hand salary will get spent, thus frittering away the advantage. Also, your tax liability may rise as the employee’s contribution to EPF gets Section 80C deduction and less employee contribution will mean more taxes. Read to know more.

How EPF contribution works

You may have noticed that in ‘deduction’ column of your salary slip contains EPF contribution item. If your monthly basic salary (+ DA) is Rs 15,000, 12% of Rs 15,000 i.e. Rs 1,800 per month is deducted from your salary and deposited in your EPF account.

Now if the EPF contribution rate is reduced to 6% of basic pay (+ DA), your EPF contribution will drop to Rs 900 per month. The Government is arguing that employees/workers will thus get Rs 900 more in their hand, as illustrated in this example. Yes, they will. But, that is only half the truth.

The flipside

The other half of the truth is that the extra in-hand salary from the EPF contribution reduction will bring more problems.

1. Higher taxes – The first problem is you may pay more taxes. The employee’s contribution to EPF gets Section 80C deduction. This means if you earlier did EPF contribution of Rs 1,800 per month (at 12% rate of basic salary), the employee’s EPF contribution worth Rs 1,800 X 12 = Rs 21,600 in a financial year could be deducted from their gross income thanks to 80C deduction. The total amount of deduction under Section 80C, including EPF, LIC, ELSS, etc., is Rs 1.5 lakh per year and the entire amount is deducted from income, thereby lowering tax outgo. EPF contribution alone took care of a chunk of Section 80C deduction.

With the reduced contributions, your annual EPF contribution figure will also go down. If the contribution rate is made 6% (instead of 12% of basic salary), using the above example you will do only Rs 10,800 as employee EPF contribution instead of Rs 21,600 earlier. This means your taxable income will potentially rise, which means you will be liable to pay more taxes.

2. Reduced savings – The second problem with lower employee EPF contribution is a consequent drop in forced savings. You may be a millennial or not, but one thing is common – the inability to save properly. All of us know we need to save more, but very few actually end up saving. In such a scenario, EPF contributions worked as an automatic way to save and invest. Because EPF is a government-run organization, our contribution money is completely safe. Since the monthly salary credited by our employer comes after EPF contributions, it was a great ‘forced’ saving.

With the reduced contributions, our ‘forced’ savings via EPF route will also come down. Once you have more money in your hands, it becomes more difficult to save. A simple test will prove this. How much percentage of salary did you save in your first job? A 5-10% is more like it. Ten years down the line your income must have risen. How much of the salary do you save now? Is it more than 10%? The answer will most likely a ‘no’. Even though your income has risen mani-fold, so have your expenses and recurring liabilities like EMIs etc. The employee’s EPF contribution acted like a compulsory savings tool and thus invisibly helped save you more. With the reduced contribution, you will likely save and invest less. Plus, the extra money in your hand will either go into spending of more money. So, net-net you really don’t benefit much even though you do get more in your hand.

3. Missing out on tax free returns – A great opportunity will be lost to earn handsome returns if EPF contribution is reduced. The EPF interest for the latest financial year is 8.65%. This means your deposits in EPF will earn this much. Do you know of any top bank, PSU or private sector, that gives 8.65% return on FDs for non-senior citizens? The answer is no. In today’s scenario, risk-free 8.65% is a great return. Even if EPF returns fall to 8%, they are still excellent. Banks are cutting FD rates, which means the incentive to keep money in FDs is going down. For instance, SBI cut FD rates twice in August so far and the highest interest rate FDs offered by that bank is 6.7%.

The loss of opportunity to earn 8.65% interest rate is pretty huge. Assume you are 30 years of age and will retire at 58. You pay 12% of basic salary + DA (Rs 15,000) as an employee contribution. This means you contribute Rs 1,800 a month for EPF on your own. An equal amount is paid by your employer. This means you will have Rs 47.12 lakh as closing balance when you are 58. Now, if the EPF rate is reduced to half i.e. 6% of basic salary (+ DA), then your EPF contribution will be Rs 900 a month. This affects your EPF closing balance and you will get Rs 33.47 lakh, or Rs 13.65 lakh less.

RupeeIQ take

The lure of in-hand salary is strong. Many youngsters prefer to take a higher in-hand salary. But, as we have explained, that extra money may neither be saved properly and you may even more tax on it. So, raise your voice and convey it against the proposal. Do not spend the extra in-hand money, if employee contribution is cut as proposed.

If your tax liability rises due to a reduction in employee contribution to EPF, try to use the extra savings to invest in tax-saving investments such as ELSS. These will help you claim more deductions and thus maintain tax outgo within a manageable limit.

Additional read: Here is how tax planning and financial planning go hand in hand

The loss of opportunity to invest in an avenue where the annual return is 8.65%, at the current rate, is huge. No comparable investment avenue today gives the 8.65% return. Hence, you may have to turn more risk-friendly and consider other investment options.

Disclaimer: Views expressed here in this article are for general information and reading purpose only. They do not constitute any guidelines or recommendations on any course of action to be followed by the reader nor are they meant to serve as a professional guide/investment advice.

Author
Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. He can be contacted on kumarsroy@rupeeiq.com