Government introduced the concept of Provident Fund (PF). Employees and the employer contribute 12% of the employees’ salary. Separate organization called EPFO (Employee provident fund organization) accumulates the contribution and invests in securities to get returns . Later during retirement, this will act as the corpus for the employees.
Willing employee can contribute more than 12% of his salary if he / she prefers a higher corpus. For this purpose, Voluntary Provident Fund (VPF) was established. It is an extension of EPF where employees can contribute as high as 100% of their basic pay.
Out of the 12% contributed by the employer, only 3.67% would be towards the PF while the remaining would be directed towards employee pension scheme. EPFO of India oversees the entire process. Law requires any company company with at least 20 employees to join the provident schemes.
Types of Provident Fund
Recognized provident fund: PF for companies with less employees. With appropriate approvals from authorities, companies can contribute.
Statutory Provident Funds (SPF): PF meant only for the Government employees. You may wonder if only employees can invest in provident funds. And the answer is not quite so.
Public Provident Funds (PPF): PF set up exclusively for a common man. In the interest of people from unorganized sector or government office, Govt. established PPF.
That’s all fine but what about the returns?! The yearly return is market-linked and usually hovers around 8% to 9%. The employee can avail the funds for his retirement or he can withdraw the money earlier in some cases which we will cover later.
And on the tax front, the returns from PF are tax free. In addition, 12% contribution made by the employee is allowed as a tax deduction under 80C. Okay, you may wonder how 12% of basic pay will matter in the long term. Well, it actually does matter a lot.
Impact of stepping up PF every year
The secret sauce is increasing the PF marginally every year. Let us consider two situations . Firstly, you’re making a fixed minimum contribution of ₹15,000 per month towards EPF. And secondly, assume you are voluntarily increasing the contribution annually at the rate of 10% which is a very achievable target (In India Average increments in 2019 was 9.3%). So first year you contribute ₹15,000 per month, second year you contribute ₹16,500 per month, third year you contribute ₹18,150 and so on.
You might be surprise by the results! If you voluntarily contribute 10% higher YoY from base of ₹15,000, you’re effectively tripling your corpus to roughly ₹6.94 crores as against earlier corpus of ₹2.13 crores.
That’s an astounding and fairly achievable return on investment (PF rate considered to stay at 8%). In conclusion, Provident fund is an important investment avenue which exponentially augments your retirement corpus. Don’t underestimate it, make a conscious effort to increase your contribution year on year.