Retirement Readiness: The VPF edge

Voluntary Provident Fund (VPF) is the voluntary contribution that an employee can make towards her public provident fund (PPF). An employee can make up to 100% of her basic salary and dearness allowance as voluntary contribution towards her PPF. The interest earned on VPF is same as that on PPF. An option like VPF offers salaried professionals much-needed flexibility with lucrative returns in the long run.

EPF interest rate now at 8.25%; these are good times for VPF

In February, the Employees’ Provident Fund Organisation, or EPFO, set the interest rate for 2023-24 at 8.25%. This is the highest rate in the last three years.

Currently, fixed deposits in scheduled commercial banks (the only equivalent of EPFO in terms of risks) will earn you lesser. There is more. The EPFO return is not only tax free at withdrawal (except in some cases, explained later), you can also withdraw it before retirement in some emergency cases (again, explained later).

The law requires all employee above a certain threshold of income to contribute 12% of the basic pay every month to EPF, and the employer typically matches this amount. Now, if you wish to increase your corpus, you can opt for voluntary pension fund up to 100% of your basic salary, along with dearness allowance. There is no matching contribution from the employer to this though.  

However, the interest rate received on the corpus remains the same and so do most of other benefits such as those on taxes, withdrawals etc.

Now, why should you at all invest in VPF, instead of receiving that money at the end of the month in your account and then using it wherever you want it to?

Benefits of VPF

Habit of savings : VPF is cut directly from your salary, inculcating the habit of savings. As there are also few restrictions on its withdrawal, you get a much larger corpus at retirement, than you would normally.

Tax : The Voluntary Provident Fund is considered one of the best tax-saving options under Section 80C of the Income Tax Act, and for a good reason. VPF is an ideal choice if you are ready to park a dedicated sum for five years, the minimum tenure of this scheme.

You can avail tax deductions of up to Rs 1.5 lakh a year under Section 80C, the interest earned on VPF is tax-free while any withdrawal made after the mandatory five-year lock-in period also does not attract any deduction.

Note that any withdrawal within five years is course taxable, even if it is a partial withdrawal.

Interest Rate: Historically, interest rate on EPF or VPF has been higher than on fixed deposits, leading to one of best returns on a quasi-government instrument.

Here is a look at interest rate on EPF over the years.

*Calculated from RBI release on weighted average domestic term deposit rates of commercial banks 

From the above graph it is clear that EPF/VPF has generated higher return than bank deposits. Even in the few years, when they did trail bank deposits, the tax advantage would have more than negated the impact.

Ease of Withdrawal: The VPF is a popular fixed-income alternative because it offers an individual the option to withdraw their investment for specific needs. It typically allows withdrawal for: 
 

• Medical emergencies 
• Wedding expenses
• Education expenses 
• Land/house purchase or construction
   

The Caveats
Unlike mutual funds, EPF or VPF are not subject to market risks but as covered earlier, this investment may attract taxes in exceptional cases:
 

1. If your investment in these funds exceeds Rs 2.5 lakh a year, interest on the contribution will be taxed under “income from other sources”
2. You have withdrawn your contribution before the completion of the five-year tenure.

VPF acts as a safety net for risk-averse individuals because of the ease of withdrawal at a highly-attractive interest rate. The recent increase in the EPF interest, which will be carried forward to VPF, is a good opportunity to cash in on this stable investment option.

Depending on your base pay, in a single financial year, you can ask your employer to deduct a total of Rs 2.5 lakh, or more, towards EPF and VPF combined. This contribution will not be taxed, while interest earned on any additional amount will be taxable.

Conclusion

One can earn 8.25% interest on this sum without making any other investment and still enjoy attractive returns due to the magic of compounding.

This fixed income fund allows you to invest until your retirement or resignation.

It also saves energy at the time of filing taxes as its benefits and deductions will be calculated in the Form 16 issued by the employer.