Employee Provident Fund - Demystified

Employee Provident Fund or EPF is by far the most common retirement planning option for the salaried class of India and in some cases the only retirement option. Even though most of the salaried employees or should I use the more popular term ‘the middle class’ have an EPF account and contribute towards it monthly, not many of us know what it is and how it operates.

 

Let’s get started, Shall We?

What is the Employee Provident Fund (EPF)?

The EPF is created by the Employees Provident Fund Organization (EPFO) of India, a statutory body of the Indian Government under the Labor and Employment Ministry. It states that an organization having 20 or more permanent employees on its payroll, should register with the EPFO.

A provident fund is a fund that is created, through contributions, to provide financial support to individuals in their future (specifically for post-retirement). The Employee Provident Fund is one such fund. Contributions are made on a monthly basis, by both employees and employers, thereby encouraging employees to save a portion of their salary each month. Investments made by millions of employees across India are pooled together and invested by a trust.

The EPF is a tax free investment instrument for the salaried class. Interest earned on it is tax free, and returns are also not taxed. You also get a deduction under Section 80C for contributions made towards your EPF.

Do You want to take a guess at the value of the total corpus of the funds accumulated by the EPFO?

It is more than Rs. 3 trillion!

Where does your Monthly EPF Contribution Go?

Currently, the following three schemes are in operation under the EPF Act of 1952, and it is into these trusts that your monthly contributions go. These are as follows:

1. Employees Provident Fund Scheme (1952)
2. Employees Deposit Linked Insurance Scheme (1976)
3. Employees Pension Scheme (1995)

In a majority of the cases, EPF, EPS and EDLIS are calculated on the basis of your Basic + Dearness Allowance (DA). Others consider your Basic + Dearness Allowance + Cash value of food allowance and retaining allowances if any as well.

What is the Employees Pension Scheme (EPS)?

This part of your monthly contribution is targeted towards offering pension on disablement, widow’s pension and pension for nominees. It is financed by diverting 8.33% of your monthly contribution away from the EPF and towards the EPS instead. This is kept to a maximum of 8.33% of Rs. 6,500, or Rs. 541. The government also contributes the equivalent of 1.17% of your monthly contribution towards the EPS.

Most people don’t realize this upper limit and think that it is a fixed % of their basic salary whereas the government has set up an upper limit. So, if your basic salary is more than Rs. 6,500/- per month, only Rs. 541/- will go towards EPS.

The purpose of the EPS is to provide for the following:

1. Superannuation Pension: A member who retires after 20 years of service and at or after the age of 58 years
2. Retiring Pension: A member who has rendered eligible service of 20 years and then retires before attaining the age of 58 years
3. Short Service Pension: A member who has rendered more than 10 but less than 20 years of eligible service
4. Permanent Total Disablement Pension: A member who is permanently and totally disabled and is unable to work/earn

What is the Employees Deposit Linked Insurance Scheme (EDLIS)?

Under this scheme, employees receive Life Insurance cover. The cost of the scheme is borne by the employer, but the life insurance received under this scheme is limited to Rs. 1,30,000/- (Which I personally feel is very low)

Most employers opt out for the EDLI and choose to have a group life insurance cover for their employees. This works out better for the employees and does not increase any cost to the employer. Usually the coverage provided under this scheme is a simple multiple of the annual salary of the employee (based on his/her grade/designation) and hence will be much higher than the fixed Rs. 1.3 lakhs cover that EDLIS offers.

A Sample Calculation - Of How Your EPF is Split Up and Saved: 

Every Month a portion of your Salary is deducted towards EPF – This will be referred to as “Employee Contribution”. Your employer too contributes a certain amount every month towards EPF – This will be referred to as “Employer Contribution”.

Employee Contribution: 12% of your basic salary + DA (Comes out of your Salary)

Employer Contribution: Another 12% of your basic salary + DA (Comes out of your Employers Pocket)

In most corporate companies these days, this employer contribution too is considered as part of your total CTC (Cost To Company) and hence can’t really be considered as coming out of your employers pocket.

The employee contribution goes entirely towards the EPF Scheme.

The employer contribution gets split up as follows:

1. 3.67% into EPF
2. 8.33% into EPS
3. 1.1% EPF Administration Charges
4. 0.5% into EDLIS (If Applicable)
5. 0.01% EDLIS Administration Charges

If you remembered to add up the numbers the total comes up to 13.61% which is higher than the 12% employer contribution that I just mentioned a few lines ago. That is because:

* The 1.1% EPF admin charges is borne by your employer and is not part of your CTC
* The 0.5% contribution to EDLIS or 0.01% EDLIS admin charges too are borne by your employer (if applicable) and is not part of your CTC.

So, if you just sum up the 3.67% that goes into your EPF and the 8.33% that goes into your EPS – the total comes up to 12% doesn’t it?

In cases, where the basic salary of an employee is more than Rs. 6,500/- most employers limit the EPS contribution to Rs. 541/- and contribute the remaining towards EPF.

For ex: If your basic salary is Rs. 10,000/-
12% of your basic salary works out to Rs. 1,200/-
3.67% of your basic salary works out to Rs. 367/-
8.33% of your basic salary comes to Rs. 833/- which is higher than the limit of Rs. 541/-

So, your employer will contribute Rs. 541/- towards EPS and contribute Rs. 659/- towards EPF (Rs. 367/- + Rs. 292/-)

In essence, the employer will contribute 12% of your basic salary just as mentioned above with the simple difference being the fact that the EPS component is constrained by an upper limit and the remaining usually goes towards your EPF.

What Happens to the Money that is accumulated in the EPF Corpus? 

The EPFO usually lends loans (to government entities) or uses the money to finance government projects. As a result, the government offers a fixed rate of interest on the money accumulated in our EPF Corpus. So, not only does your corpus grow every month (with additional monthly contributions) but also earns a fixed and regular interest.

When is the Interest Calculated/Credited in our EPF Account?

The Interest is usually calculated as well as credited into your EPF Account at the end of each financial year. Compound interest is paid on the amount standing to the credit of an employee as on 1st April of each year.

Hope this article covered all the basics you needed to know about the Employee Provident Fund Scheme. In the next article, I will try and give you a realistic idea of how much pension you may get post retirement through the EPS.