Retirement is one of the most important stages of any employment which every individual has to undergo this phase. There are different ways to pass this phase happily and smoothly like investing in mutual funds, stocks, real estate but one of the most common instruments amongst them are EPF and NPS.
The recent buzz by the Govt of India to Comment on Amendment in the Employees Provident Funds and Miscellaneous Provisions (EPF & MP) Act, 1952 has made us revisit two important savings schemes, The NPS and EPF. There are some new proposals relating to these schemes. Let’s have a look into these proposals
One of the changes which the Government has proposed is the change in contribution amount by an employee and employer. Currently, the contribution by the employer towards EPF is 12% of basic + DA, whereas an employee can contribute more than that. It is being proposed to reduce the same to 10%, both by employee and employer.Apart from this, there are new proposals to increase penalty amounts for employers who fail to follow the regulations of the Act. The EPF is not much affected by the new proposals but gives us a thought to understand, compare it with NPS, another contemporary pension scheme.
What are these pension schemes?
EPF: Employee Provident Fund – It is a pension scheme, which helps an employee accumulate a corpus for retirement pensions. For any employed person who earns a minimum of Rs.15,000 per month, 12% of basic salary + DA is deducted monthly towards EPF contribution and this is mandatory.
NPS: National Pension System – This is also a pension scheme but the contribution is voluntary. In this a subscriber will have to invest a sum of Rs.100 at the time of registration. Though there is no minimum contribution requirement per year, it is recommended that a contribution of at least Rs.1000 per year is made to ensure a reasonable pension after retirement.
What is the Composition of EPF & NPS?
For the investments to grow, EPF accumulations are invested in pension funds which are nothing but purely debt instruments like bonds, NCD’s and CP’s offered by corporates and government. As an individual investor, one doesn’t have any control over such investments. In NPS one has an option to choose their investment avenues. NPS offers two approaches as below:
- Active choice: In this the investor is given option to choose their fund manager and the ratio of funds to be invested among
- Asset class E – Equity and related instruments
- Asset class C – Corporate debt and related instruments ·
- Asset class G – Government Bonds and related instruments ·
- Asset Class A – Alternative Investment Funds including instruments like CMBS, MBS, REITS, AIFs, Invlts etc.
- Auto choice – There is a Lifecycle Fund and the investor has to select a Pension Fund Manager and his / her funds will be invested as per the Life cycle fund matrix on the basis of the age of the subscriber.
Comparison between EPF & NPS:
As an investor one can look at the following to compare both.
|Authority||EPFO formed under Employees’ Provident Fund and Miscellaneous Provisions Act, 1952||NPS formed under Pension Fund Regulatory and Development Authority (PFRDA)|
|Mandatory||Yes for employee earning more than Rs.15,000 per month||Voluntary|
|Min/Max Contribution||The minimum contribution is Rs.1800/month and the maximum is unlimited.||The minimum contribution is Rs.500 in Tier I and Rs.1000 in Tier II and no maximum limit.|
|Who can Contribute?||The wage level should be equal to or greater than Rs.15,000 per month.||Any person can contribute|
|Investment structure||Govt Securities – Min 45%, Max 50%|
Debt Securities and Term deposits of banks – Min 35%, Max 45%[Old]
Min 20%, Max 45%[New]
Money Market Instruments -Upto 5%
Equities/ETF’s/Index funds – Min 5%, Max 15%
Alternate Investments – Upto 5%
|Active choice: Individual has an option to choose his investment structure|
(i) LC75 – Aggressive Life Cycle Fund: This Life cycle fund provides a cap of 75% of the total assets for Equity investment.
(ii) LC50 – Moderate Life Cycle Fund: This Life cycle fund provides a cap of 50% of the total assets for Equity investment.
(iii)LC25 – Conservative Life Cycle Fund: This Life cycle fund provides a cap of 25% of the total assets for Equity investment.
|Lockin period||Till retirement||Till age of 60 years|
|Expected growth||8.65% per annum||Depends on the asset allocation|
|Premature withdrawal||Allowed under certain conditions like medical emergency, marriage, home purchase or repayment of home loan or repairs and renovation, unemployed for more than 2 months||Allowed under certain conditions like medical emergency, marriage of children, higher education of children and home purchase or construction provided only house.|
|Maturity amounts||Entire corpus||60% at the age of 60, rest to be utilized for purchasing of annuity|
|Taxation||Contribution is exempted, Growth is exempted and Withdrawal is exempted||In Tier I, for government employees, exemption upto 2 Lakhs. For others exemption upto Rs.50,000|
An example of Choosing EPF Vs NPS
Ajay is 25 years old, he is married and has a son, Suraj who is 1 year old. Ajay is currently earning Rs.75,000 per month and is spending Rs.35,000/month. Based on his lifestyle he is aiming for Rs.50,000 per month as pension post retirement i.e. 60 years of his age until 85 years of his life. Now based on his requirement, let’s see what amount of monthly investment he needs to do and compare such investment in EPF and NPS to understand a better product. Ajay would need approx. Rs.6 Crores as corpus on the date of retirement to achieve his retirement goal. The options available to achieve the above mentioned corpus are either he can contribute towards EPF or NPS or a combination of both.
What if you choose Employee Provident Fund (EPF) ?
Assuming he chooses EPF as his retirement vehicle, the monthly contribution should be Rs. 22100, with the prevailing interest rate of 8.65%. in this scenario he will only get a tax benefit of Rs. 1,50,000, whereas rest of the contribution of Rs. 1,15,000 is taxable.
What if you choose National Pension System (NPS) ?
Assuming he chooses NPS as his retirement vehicle, the monthly contribution should be Rs. 17800, with the average return on investment of 9.5%. in this scenario he will get a tax benefit of Rs. 2,00,000, whereas rest of the contribution of Rs. 13,000 is taxable, this is in case he is a government employee or else the max benefit is limited upto Rs. 50,000 .If you look at risk factors, EPF is exposed to interest rate risk, which means periodical revisions by the government may lead to fall in interest rates over long periods. At the same time NPS attracts market risk, where there is high volatility leading to variable returns, due to some portion of exposure towards equity. Considering the retirement benefits, EPF allows to withdraw all the corpus Rs.6 Crores and choice of utilization is with investor, whereas in case of NPS investor can only withdraw 60% of the corpus and the rest of the 40% he has to compulsorily purchase annuity.
Though EPF and NPS have their own merits and demerits, it is suggested to go for a combination of both schemes to take advantage of NPS returns over EPF, Taxation benefits of Rs.2 Lakhs(if invested in both) and Risk in EPF as it is virtually zero.