If you were planning for your retirement and depended heavily on the Employee Provident Fund (EPF), then it is time you did your financial planning again.
The government has brought down the interest rate on EPF and has left many salaried employees who get EPF a bit peeved. Suddenly, there are other investments out there which seem to be having a better rate of interest.
What is the Employee Provident Fund (EPF)
The Employees’ Provident Fund Organisation (EPFO) manages the EPF of around 4.6 crore subscribers. EPF is a social security avenue for employees in India. The EPF covers organizations that have 20 employees and those having earnings upto Rs 6,500 per month are eligible to be covered.
The employee contributes 12% of his basic salary each month and the employer also adds another 12%. That is a meaty 24% each month invested for long term for retirement. Since this is a forced saving in a risk free investment avenue, it works well for investors in the long run.
In 2010-2011, the EPFO had upped the interest rate from 8.5% to 9.5% after it found Rs 1,700 crore surplus in its books of account though the finance ministry was not happy with the move as it suspected that there could be a shortfall.
This week, the government cut the interest rate on EPF savings for 2011-12 to 8.25%.
The move came at the back of the fact that the surplus was not enough to support the 1% difference that was promised last year and income estimates done were incorrect leading to a Rs 500 crore shortfall.
Within 10 years, the EPF rate has come down from 11.25% in 2000-2001 to the current interest rate of 8.25% for 2011-2012. So it is obvious that you cannot depend on EPF to provide money for you for your retirement. You need to depend on other investment avenues like diversified equity mutual funds which help in long term investing and beat inflation.
So what is the impact ? If this rate of interest is to continue in the future always, then the impact is huge. Now historically, when reserves have been found to be available with the EPFO, they have jacked up the interest rate. However, if that was not to be done and we were to continue with the same rate in the future, let us see what the impact will be.
Assume a basic pay of Rs 10,000 per month which increases 5% year on year. For a person who has just started his career, he might might have 35 years to go before retirement.
In the below table, the first column “Total no of years” depicts the number of years for which the EPF will accumulate.
The second column depicts the maturity value which EPF fund would have fetched you had it remained at 9.5%. Similarly, the third column depicts the fund value that will accumulate in your EPF account if the rate of interest is 8.25%.
Finally, the fourth column defines the decrease in percentage terms due to the new interest rate.
As you can see, the longer your money is to grow at the current lower rate of 8.25%, the larger will be the decrease in fund value. An approx. 22% decrease over 35 years and 18.8% over 30 years is a very large reduction in corpus.
Given this, it is best if investors look at equity to build up a corpus that will help them in their retirement.
The current rate of 8.25% is lower than the other small savings interest rates making EPF look a bit pale in comparison. Even FDs deliver better than this. I sincerely hope we see better interest rates on the EPF otherwise investors will be left stranded.