DT Personal Finance: When to start voluntary contributions to your PF?

CHENNAI: If you are already making a small EPF contribution (via salary deductions) each month, then you might have heard or thought about increasing the contributions. This can be done via VPF (or Voluntary Provident Fund).

But should you increase your PF contributions via VPF? Let’s try to answer that. EPF is a solid retirement savings tool. But for most, it won’t be enough on its own. Given the rising life expectancy and longer retirements, you need to save more for your golden years.

But before we understand when VPF makes sense and when it doesn’t, let’s see the EPF taxation. In the 2021 Budget, the government announced if an employee’s total annual contribution to EPF (including via VPF) exceeds Rs 2.5 lakh, then the interest earned on the incremental amount above Rs 2.5 lakh will be taxable as per the employee’s tax slab.

So, for example, if your contribution to EPF is Rs 3.5 lakh in a given year, then the 8.15% interest earned on the excess Rs 1 lakh (after the first Rs 2.5 lakh) will be taxable. That means that if you are in the 30% tax slab, the post-tax returns on the interest earned on that incremental Rs 1 lakh will be 5.71%.

Remember EPF interest for contributions up to only Rs 2.5 lakh per year is tax-free. Beyond that, it is taxable. On the other hand, PPF allows you to invest Rs 1.5 lakh maximum but the interest of 7.1% is fully tax-free. So here is how to decide:

 If your (employee) EPF contribution is below Rs 2.5 lakh in a year, then start VPF with an amount that the total contribution to EPF+VPF is Rs 2.5 lakh. So, if your regular EPF contribution is Rs 15,000 per month or Rs 1.8 lakh per year, then you can begin a VPF of about Rs 5,800 per month (or Rs 70,000). That way, the total of EPF+VPF will be just below Rs 2.5 lakh the entire EPF+VPF contribution will generate 8.15% tax-free.

If you need to invest more in debt, then next go for PPF, where you get 7.1% tax-free up to Rs 1.5 lakh contribution

So, first Rs 2.5 lakh goes towards EPF+VPF, then next Rs 1.5 lakh goes to PPF

If you still need to invest more in debt/PF, only then you can consider further increasing your VPF contributions. The contributions that exceed Rs 2.5 lakh will have their interest taxed as per tax slabs

The above assumes we are looking at debt investments only.

But if you are at least a moderately aggressive investor, and are comfortable investing in equities, then you should also have some allocation equities via mutual funds.

How much you invest in equity funds versus provident funds will depend on your risk appetite and time horizon.

If you still have over 10 years for retirement, you can easily have at least 50% allocation to equities (via equity funds). Having some allocation to equity will help you generate inflation-beating returns in the long term. You can look at equity funds from largecap index funds, flexicap funds, midcap funds to pick schemes suitable for your retirement bucket.

So, while we began this discussion with the question about when and whether to start your VPF contributions, the first thing to ensure is you get your asset allocation (equity:debt) right and then within the debt bucket, think about starting/increasing VPF contributions. And if you are not sure about the right strategy, better to consult an investment advisor to help plan your finances.