Is Employee Provident Fund still a good choice?

There is a general sense of despair with Employee Provident Fund (EPF) rates being confirmed at 8.1% per annum for FY 2021-22, the lowest in four decades. Some subscribers have been looking at alternate options but are unsure because these options do not come with a sovereign guarantee.

The EPF scores high due to its tax-free, risk-free return and, above all, compounding effect. Often, subscribers do not realise what a big difference the compounding effect has on the retirement corpus. Rs 10,000 invested every month @ 8% per annum on compound interest grows to Rs 1.49 crore in 30 years as opposed to Rs 39 lakh on simple interest. In fact, this is why I am not in favour of partial withdrawals in EPF. Partial withdrawals are typically for house purchases or emergency use.

While EPF has its benefits and beats inflation too, it can only build the retirement corpus to a particular level. Also, the present value of Rs 1.49 cr (in the above example) would be Rs 26 lakhs only, which is grossly insufficient to manage retirement needs. Thus, along with the EPF, one needs to add other investments, which can yield returns higher than EPF, in the long term.

Many options exist like Public Provident Fund (PPF), pension schemes from insurance companies, equity mutual funds and the National Pension Scheme (NPS). PPF returns are lower than EPF and there is a restriction on the investment amount, not making it a good proposition to add on to EPF.

Pension schemes, equity funds and NPS invest in equity & debt markets and do not give a guaranteed return. Among these schemes, pension schemes from insurance companies have the highest fees, due to which the investor returns in these schemes are only 4-5% per annum. They are certainly not a viable option to plan for retirement. Even PPF is better.

NPS has various investment choices and investors can choose the allocation to equities and bonds as per their risk-taking ability. Those investors who are not able to decide the allocation can opt for the auto choice where the funds are allocated as per a predetermined mix based on age. The allocation to equity reduces gradually as one grows older.

I find NPS (active equity) to be a great way to save for retirement. It has negligible costs and the exposure to equities can provide good returns in the long term. Since the funds are locked in till age 60, it makes for disciplined investing. Investors will not be tempted to exit to chase a trending investment. NPS comes with great tax benefits – tax deduction on the subscription, which is over and above Sec 80C & retirement corpus being partially tax-free. While the pension is taxable, it is preferable for those subscribers who want regular income in retirement.

Investors who prefer some flexibility can consider equity funds but must be careful with their choice of funds. Broad-based funds like Flexi-cap funds would work well. In addition, investors need to be disciplined and not churn the fund investment on the first sign of volatility or underperformance.

The EPF along with NPS (active equity) is a good and easy combination of schemes to invest in for retirement. Fill it, shut it and forget it!