In a recent landmark ruling, the Supreme Court said that employees can contribute to the Employee Pension Scheme (EPS) without any upper limit.
How EPF Works
Both employer and employee contribute 12% each of the salary to the EPF account. Out of the employer’s contribution, 8.33% is allocated to the employee’s pension scheme. You can claim the pension under the EPS when you cross the age of 58. However, you must complete 10 years of service in order to be eligible to claim the pension, otherwise, you can only claim a refund of the EPS amount.
The formula for the EPS calculation is as follows:
Pension = Pensionable Salary* Service Period/70
The rules also guarantee a minimum pension of Rs 1,000 per month. However, previously a ceiling of Rs 15,000 per month was enforced on the salary that could be contributed to the EPS. This meant that only Rs 1,250 per month could be contributed to the EPS.
Thus according to the formula, your EPS calculation for 10 years of service would be:
15,000*10/70= Rs 2,142 per month
This is a highly generous formula. If you had saved an equivalent amount (8.33% of Rs 15,000) in the ‘normal’ EPF or PPF, you would have built a corpus of about 2.17 lakh in 10 years. This would generate about Rs 1,400 per month at an interest rate of 8%. Compare this to the Rs 2,142 you would have received under EPS.
However, a 1996 amendment to the EPF Act allowed employees to raise this proportion to 8.33% of the full salary rather than just Rs 15,000. In practice though, the Employees’ Provident Fund Organization (EPFO) did not allow this to take place. This policy of the EPFO was challenged by the petitioner.
What the court ruled
The Supreme Court ruled in favour of the petitioners that the EPF contributions could be 8.33% of the full salary (and dearness allowance). It allowed the petitioner to make backdated payments for the years in which he had missed contributing (about Rs 15 lakh). In return, his pension was raised by the appropriate amount. The next effect caused a significant hike in the employee’s pension (from about Rs 2,300 per month to Rs 30,500 per month). Also, 50% of the pension is payable to the employee’s wife after his demise.
What it means for you
If your employer deducts EPF contributions (and hence EPS contributions), you can raise these to 8.33% of your full salary. This will mean having a larger share of your earnings deducted and you will have less money to spend before retirement. However, you will be able to save a reasonable pension amount, when you retire. It is important to note that you also have alternative options such as mutual funds, NPS and PPF for your retirement saving. Of these, both mutual funds and NPS are market-linked and may allow you to build a larger retirement corpus than the EPF.