Understand your Voluntary Provident Fund

By Teena Jain Kaushal

For risk-averse investors who want to invest for their retirement, Public Provident Fund (PPF) seems to be a good choice. But considering there is a limit on the maximum amount that you can deposit in your PPF account every year, and that inflation will certainly undo part of your wealth creation effort, you need other options to augment your savings.

Voluntary Provident Fund (VPF) is one such way to bump up your retirement savings. Besides, it brings you tax benefits as well.

What is VPF? Every month, your employer deducts 12 percentof your basic salary (including dearness allowance) towards Employees’ Provident Fund (EPF). Actually, you can contribute a lot more—over and  above the compulsory deduction of 12 percent. In fact, you can contribute the entire salary (i.e., remaining 88 percent) towards VPF even if your employer is paying only 12 percent.

The biggest advantage of a VPF account is that investments in it are made from your pre-tax income.

Increasing VPF contribution. If you want to increase your VPF contribution, you can do so at any point during your employment. However, employers tend to provide this option only at the start of the financial year.

Says Manish Sabharwal, CEO, TeamLease, a staffing company: “You can increase voluntary contributions by writing to your employer. However, mid-year stoppage may not be possible (if you think the contribution is too high to continue).”

Tax Benefits. Employees’ contribution. It is eligible for deduction under Section 80C of the Income Tax Act, subject to a maximum of Rs1 lakh.

Interest income. It is not taxable unless the interest rate exceeds the statutory rate, which is 9.5 percent at present.

Redemption. It is tax-exempt, but taxable if withdrawn within the first five years of service.

2012-13. Rates are announced generally at the end of every year. Recently, for 2011-12, the Employees’ Provident Fund Organisation announced a reduction in interest rate to 8.25 per cent from 9.5 percent in 2010-11. For 2012-13, it has been reported to be fixed at 8.6 percent.

Who should do it? For risk-averse investors who are close to their retirement, VPF is a good option. However, if the Direct Taxes Code (DTC) comes into effect next year, your entire maturity proceeds may become taxable.

Considering that, it makes sense to make greater contributions this year for saving on taxes. Says Kulin Patel, head of benefits practice, India, Towers Watson, a consultancy firm: “First, it is an individual decision. Second, one should remember that the investment is for the long term. Third, the employee should remember that interest income and maturity proceeds are tax-exempt.”

So, next time you sit down to plan your retirement, don’t ignore your VPF contribution. It might just be the right supplement for you to accumulate a decent retirement kitty.

VPF: THE LOWDOWN

• You can contribute as much as your entire salary (basic salary plus dearness allowance) towards EPF
• An advantage is that investments are made from pre-tax income
• Good option for those who are close to their retirement and want to augment their savings
• Mid-year stoppage of contribution may not be possible
• Voluntary contribution is eligible for deduction under Sec 80C
• Interest income is not taxable unless it is higher than 9.5 percent
• Redemptions are tax-free, unless made before the expiry of 5 years
• For 2011-12, EPFO has announced an interest rate of 8.25 percent