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Apart from retirement planning and pension, the EPF scheme also offers tax benefits, which are not available under mutual fund equity investments.
For FY 2024-25, the EPF interest rate has been set at 8.25 per cent. (Photo Credit: Instagram)
The Employees’ Provident Fund (EPF) scheme offers an opportunity to salaried workers in the private sector to build a retirement corpus. The government-backed scheme has been designed to offer financial protection to the private sector employees in their retirement years. Under the scheme, an employee contributes 12% of the basic salary and dearness allowance every month. An equal amount is also contributed by the employer.
It offers a secure and fixed interest rate, which has been set at 8.25 per cent per annum for FY 2024-25.
On the other hand, there are equity assets, such as stocks and mutual funds, that come with the potential of delivering much higher long-term returns than most fixed-rate investment options.
However, the question here is, can 8.25% EPF returns beat a potential 16 per cent annual return from equity schemes over a horizon of 5 years?
CA Compares EPF and Equity Returns
In a recent LinkedIn post, Chartered Accountant Nitesh Buddhadev explained how the EPF investments can beat the equity schemes despite lower returns.
He took the example of two employees having a gross income of Rs 26 lakh and a basic pay of Rs 1 lakh each. Both of these individuals began their employment after September 1, 2014, with a base wage and dearness allowance (DA) of more than Rs 15,000 per month. Both have opted for the new tax regime for filing their income tax returns (ITRs).
Adding to this, he shared that if the first employee chooses a 12 per cent EPF limit, the monthly EPF contribution will be Rs 12,000. As the employer matches the amount and pays Rs 12,000, the total monthly contribution to EPF will be Rs 24,000.
For the employees who joined after September 1, 2014, and get a basic salary of more than Rs 15,000, the entire 24 per cent goes to EPF, as they are not eligible for the Employees’ Pension Scheme (EPS).
Contrary to this, the CA uses the example of another employee who decided to opt out of EPF and instead invests Rs 24,000 in equity. New employees who join after September 1, 2014, and have a base salary of more than Rs 15,000 have the option to opt out of the EPF.
Now, according to the CA, since this employee is liable to pay tax on the increased portion of salary of Rs 12,000 (which would have been the employer’s EPF contribution), the effective equity investment will be Rs 20,256 rather than Rs 24,000.
The CA estimated a total of Rs 3,744 per month as tax liability, which included a 30 per cent flat tax rate and a 4 per cent health and education cess.
How Does Taxation Impact Overall Returns
The CA estimated the first employee’s EPF corpus at an interest rate of 8.25 per cent over a five-year period to grow into Rs 17.75 Lakh.
However, at an estimated 11 per cent return on equity investments during the same 5-year period, the corpus for the second employee (after capital gain tax) would grow into Rs 15.75 lakh.
Result? Even though the equity investments provided higher returns of 11 per cent, PF outperformed them with only 8.25 per cent returns due to the tax advantage.
Going by the calculation, the CA suggested that in order to reach a corpus of Rs 17.75 lakh, the equity investor must receive a 16 per cent (post-tax) annualised return over 5 years.
Though it may sound surprising, EPF can help you get higher returns compared to equity investments due to tax benefits.
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A team of writers and reporters decodes vast terms of personal finance and making money matters simpler for you. From latest initial public offerings (IPOs) in the market to best investment options, we cover al… Read More
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