EPF rate to stay at 8.5% - Part 2

This article is an continuation EPF rate to stay at 8.5% - Part 1 which is a two part series.

Given the long term nature of the money that one is planning to put into the EPF, it is very important that the returns of the money invested in other options is reasonable, competitive and at the same time small differences in the returns over long periods of time make a significant difference over a period of 25-30 years.

Here is one option instead of contributing to EPF over and above the mandatory contribution.

Unit Linked Unit Plan (ULIP) - Unit linked plans are those that not only give you insurance cover but over long periods of time have given good returns even in the most conservative of the plans where all the money is invested in debt related instruments. Here are a few distinct advantages of ULIP over the EPF.

a. Tax treatment - Given that one is entering into a contract with the insurance companies today, the treatment of the income from ULIP after the maturity of the policy is tax free. However, in the case of EPF, while withdrawals are tax free today,it is quite possible that the withdrawals will become taxable if one goes by the recent news paper reports about taxing the withdrawals.

b. Alteration of risk profile - One has the ability to alter the profile of the investment over the life of the covered period by moving between equity and debt. However, in EPF no such facility exists.

c. Discipline in investment - Given that one gets into the contract with the insurance company for a committed investment during the tenure of the policy, it instills a sense of discipline where one is forced to continue the investment which if one does sustain, loses significant benefits of the previously made investment. While, a similar facility exists in contributing to EPF also, such commitment is not a must and no penalties are levied for lack of contribution.

EPF rate to stay at 8.5% - Part 1

The Central Board of Trustees of the Employees Provident Fund (EPF) have recommended payment of 8.5% pa.a interest to the members of the fund for 2006-07. So what does this mean for a long term investor who contributes more than what is mandatorily required to be contributed by the employee as per the rules stipulated in India (Employees have to compulsorily put 12 per cent of their monthly salary of up to Rs 6,500 in the EPFO). Let us see if it is still worthwhile to invest in EPF and compare it with other alternatives (read as competitors) that one has got at this point in time.

Given below are some of the key considerations when one invests in EPF over and above the mandatory minimum as stipulated by the Government of India.

1. Typically investments are considered as long term with little or no liquidity i.e. one cannot withdraw money easily before retirement though one can withdraw certain amount as specified by the EPF board for some purposes that have been identified by them such as child’s marriage, repayment of home loan, medical emergency and a few more.
2. Interest earned on the deposit is tax free and hence the compounding effect over long terms of time is beneficial.
3. One will get income tax benefit under Sec 80C of the Income Tax act.
4. Withdrawals are tax free at the time of retirement.
5. With the government taking some steps on pension reform, this instrument could get better and could give scopes for higher return.

Thus for investors who are investing for long term point of view, a guaranteed return of 8.5% is good for the moment.

However, there are competing products that do not give such guaranteed returns but have performed equally when compared with the returns generated by EPF and at the same time provide other benefits. We will look at the same in the next part of this series.