With taxation on EPF interest should you move your investments to mutual funds or NPS?

  • Marisha Bhatt
  • May 04 2021
  • 6 minutes
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What is the first investment option that comes to the mind of any salaried person? It is undoubtedly EPF. Employees Provident Fund (EPF) has long been a preferred investment option of the salaried class in India.

Multiple benefits like tax exemptions, building a corpus fund for retirement benefits, etc. and easy deductions from the salary of the person make it a very lucrative and easy investment destination. Another important advantage of EPF is that it belongs to the  Exempt-exempt-exempt (EEE)  category where the contribution made, the interest earned and the amount received at the end of maturity is not taxable under the Income Tax Act, 1961. 

Recent amendments to EPF in Budget 2021 and its impact on investors

The recent budget of 2021 has proposed to tax the interest component of the employee contributions above Rs. 5,00,000 if an employer contribution is not present. With this change, EPF will no longer fit into the EEE category. This move was proposed keeping in mind the high-income bracket salaried class who would park higher funds in this investment scheme to enjoy the tax benefits. This amendment is not perceived to impact the smaller or low-income salaried persons.

This recent amendment may push the salaried class away from EPF to other similar schemes like NPS or an entirely different product like mutual funds which provides higher returns.

Comparison between EPS, NPS, and mutual funds

Before going ahead with seeing if you should move your investments, let us consider the basic comparison between the three investment products to get a fair idea of which investment is best suited to any investor based on their risk, returns, and other parameters.

Category EPF NPS Mutual Funds
Contribution Employees have to mandatorily contribute to the EPF account up to 12% of their basic salary and dearness allowance. Higher contribution in Voluntary Provident Fund (VPF) is permissible. Contribution to NPS is mostly voluntary (except in the case of few government employees) Contribution to mutual funds is based on the discretion of the investor. There may be a minimum subscription through SIP set by the fund house which has to be met by the investors to invest in the fund.
Returns Returns on EPF are based on the interest rate as notified by the government from time to time. The current interest rate applicable from April 2021 is 8.5% per annum. The returns in the case of NPS are linked to the equity & debt component of the fund. Historical returns show they are higher than that of EPF The returns on mutual fund investment are subject to market risk but it is usually higher in the bull phase of the market when compared to the other types of investment products mentioned here. In the long term, returns are higher than EPF.
Complete Withdrawal Investors can withdraw from the fund only in case of attaining the age of 58 years or after 2 months of unemployment. Investors can withdraw 60% of the fund when such investors attain 60 years of age. Balance 40% of the fund has to be reinvested into any annuity or pension product. Withdrawal of the fund can be done at any point especially in the case of open-ended funds. Close-ended funds or ELSS funds have a fixed lock-in period after which the investor can withdraw from the fund easily.
Taxability EPF belongs to the EEE category of investment where the initial investment interest earned and the amount withdrawn at the time of maturity is tax-free. As per the recent amendment, interest earned on contribution over Rs. 500,000 will be taxed in the hands of the investor. In the case of NPS, the amount withdrawn at the time of maturity (60% of the fund) is tax-free while the balance is taxable in the hands of the investor. Mutual funds are subject to capital gains based on their period of holding and the type of fund invested in.
Tax deduction Investors can get tax deduction u/s 80C up to Rs. 1,50,000 for contribution to EPF Investors can get tax deduction u/s 80C and section 80CCD up to Rs. 2,00,000 for contribution to NPS ELSS mutual funds are the type of funds with tax-saving options. Also, investors can get a tax exemption of up to Rs. 1,00.000 in case of long-term gains on equity-oriented mutual funds. Investment in other mutual funds do not get tax exemptions

Is it better to move from EPS to NPS/ Mutual Funds?

The recent tax amendment will see a levy of tax on the interest portion of higher contributions to EPF where earlier parking your money for long-term benefits was a relatively easier option. This amendment is likely to affect the high salaried individuals and not the low/mid-income group. 

Despite the amendment, experts believe that the influx of investment in EPF will continue to increase as it still is a high interest-providing investment. The only change that can be viewed is that investors will have to first exhaust the benefit of contribution up to Rs. 5,00,000 in EPF and then can move to PPF, mutual funds, or other similar investment products like NPS.

The tax deductions under NPS are up to 10% of the salary in the case of salaried individuals and 20% for self-employed individuals. The maximum tax deduction of Rs. 1,50,000 is eligible for employee and employer contribution together. As there is no employer contribution for self-employed individuals, the tax exemption is higher at 20% of gross income. Additionally, investors also get tax deductions under section 80CCD(1B) making the total tax deduction under NPS up to Rs. 2,00,000. Experts believe that NPS will continue to attract high investment on account of higher tax deductions and higher returns due to the equity component in the scheme.

Mutual funds on the other hand are completely different but flexible products with good liquidity and the potential to make good returns when invested over a long time. There are different varieties of mutual funds which can help you balance your risks, as mutual funds are market-linked.

With investment platforms like Finity, you could easily invest in mutual funds based on the suggestions of our smart recommendation engine that picks funds for you based on various critical parameters through Finity’s proprietary research methodology

Conclusion

An ideal investment portfolio will be a combination of the three investment products mentioned above. This will provide the necessary hedge against the volatility of the mutual funds at the same time will generate higher returns for the investor as compared to a plain vanilla investment in retirement products like EPF or NPS.

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