The EPF factor

Up to fiscal year 1988-89, Section 80C laid down that only 20 per cent of the basic salary or Rs 10,000, whichever was lower, could be contributed to the Employee's Provident Fund.

Fiscal year 1989-90 dropped the Rs 10,000 monetary limit but retained the percentage limit. Even this restriction was dropped when Section 80C was replaced by Section 88 in Finance Act 1990.

Now, there is no limit stipulated either by way of a percentage of basic salary or fixed monetary limit.

The employee's contribution consists of the statutory minimum and the voluntary additional contribution made by the employee.

To begin with, PPF interest was 4.8 per cent in 1968-69. It was slowly and steadily raised to 12 per cent way back in 1986-87 and stayed at that level till January 15, 2000. It was the best avenue for tax-saving. EPF rates were also raised in unison.

On January 15, 2000, for the first time, the PPF rate was pushed down to 11 per cent. The EPF rate was untouched and remained at 12 per cent. On March 1, 2001, the PPF rate was further drastically reduced to 9.5 per cent.

The EPF rate was revised from 12 per cent to 9.5 per cent with effect from April 1, 2001. Finance Act 2002 reduced the PPF rate to 9 per cent and now, Budget-03 proposes to reduce it to 8 per cent with effect from March 1, 2003.

Fortunately, the EPF rate has been retained at 9.5 per cent.

Investment strategy

This provides an excellent opportunity to all employees to contribute to their EPF to the hilt. Yes, a contribution upto Rs 70,000, aggregated with some other investments attract the rebate under Section 88, unless the income is over Rs 5 lakh in which case, the rebate is nil.

Contribute over this limit, even if the extra contribution does not attract any rebate. The 9.5 per cent tax-free interest is extremely attractive.

Realise that the contribution has no limits and therefore, theoretically, any employee can pour his entire salary into EPF, every month.

This avenue has emerged as the best parking place for investible funds of any salaried employee especially anyone close to retirement.

Take care

There are only two points to be considered before taking the leap:

There is talk that the EPF rate may be reduced by 100 basis points in the near future. The near future may not be the current fiscal year 03-04, because of the electoral compulsions. Even if the rate is reduced during the current year, EPF will still retain its charm at 8.5 per cent since the rates on all the other safe avenues have already dropped far below this level.
There are numerous restrictions on partial or full withdrawals. The entire corpus, along with interest can be withdrawn only on retirement. If the employee quits one job and moves to another, he is supposed to transfer the entire corpus to the new employer. Even loans are not easily available. Consequently, only employees for whom illiquidity is not a problem, will do well by increasing their voluntary contribution to the hilt.

The best strategy for VRS employees

A person who is retiring or opting for VRS does not face this lock-in problem. The Fourth Schedule, Part-A dealing with Recognised Provident Funds, Rule 5(3) of the ITA states:

At the request made in writing by the employee who ceases to be an employee of the employer maintaining the fund, the trustees of the fund may consent to retain the whole or any part of the accumulated balance due to the employee to be drawn by him at any time on demand;
Where the accumulated balance due to an employee who has ceased to be an employee is retained in the fund in accordance with the preceding clause, the fund may consist also of interest in respect of such accumulated balance;
The fund may also consist of any amount transferred from the individual account of an employee in any recognised provident fund maintained by his former employer and the interest in respect thereof.

In other words, any retiring employee is free not to withdraw his funds from EPF, as long as he wishes to do so, and take even years before he finally effects the exit. He will earn tax-free interest during this period.

Yes, the interest is not fixed and may be reduced from time to time. It is evident that at any given juncture, the rate of EPF will be higher than all the rest of avenues with comparable safety, irrespective of whether there is election compulsion or not.

The future is always unpredictable. It maybe that some other avenue, new or old, will emerge from nowhere and race ahead of EPF.

That's pretty unlikely, but if and when such an event does take place, the retiring employee can and should seize the opportunity and shift quickly to the better avenue.

Legal issues

Allow me to draw your attention to an important aspect. Some experts feel that once an employee retires, the employer-employee relationship ceases.

Thereafter, the corpus of EPF, if left with the ex-employer, gets the colour and character of a Co-FD. Consequently, the interest becomes fully taxable.

I am not an expert but I do not subscribe to this view. If this view is accepted, the very existence of the Rule-5 reproduced hereinabove loses its relevance.

To sum

All employees should park their investible funds in EPF if they can bear the non-liquidity of this avenue, unless there are some compelling constraints.

Retiring employees, particularly those opting for VRS do not face any liquidity problems since an easy any-time exit is available to them.