Many are crying as if their door to wealth is ended after this new tax law. However, we still suggest EPF is the best option for your debt part of your retirement goal.
In Budget 2021, the EPF taxation rules changed. Now, if an employee contributing more than Rs.2.5 lakh in a year, then such an additional amount is taxable for the employee.
There are many individuals who have the mandatory contributions to EPF. For them no option but to pay the tax. However, those who are contributing to it through VPF then felt this new taxation law as if a breach of their trust in this Government.
However, think for a while from the Government’s point of view. Generating 8.5% GUARANTEED returns is not so easy. Hence, to reduce their obligation on EPF, the Government introduced this taxation rule so that one may not use the VPF route.
EPF is the best debt instrument for your retirement goal. Who will give you the current 8.5% tax-free returns in the current scenario?
# Post Tax Returns are still higher than any other instruments
Let us assume that your EPF contribution is Rs.4,00,000 a year (inclusive of EPF+VPF). Now in this, interest earned on up to Rs.2,50,000 is tax-free. On the remaining Rs.1,50,000, the interest earned is Rs.12,750. Do remember that interest on EPF is compounded monthly but credited yearly. However, for simplicity sake, we am considering the 8.5% interest on the whole Rs.1,50,000.
Now you have to pay the tax on this Rs.12,750 as per your tax slab. If you are under the 30% tax slab, then your post-tax returns will be Rs.8925 (5.95%). If you are under a 20% tax slab, then your post-tax returns will be Rs.10,200 (6.8%). Finally, if your tax slab is 10%, then your post-tax returns will be Rs.11,475 (7.65%).
Assuming you are under the highest tax bracket of 30%, who will give you the 5.95% tax-free returns in the current scenario?? Bank FDs? Tax-Free Bonds? RBI Floating Rate Bonds or NCDs??Debt Funds (Refer to the taxation of Debt Mutual Funds at “Mutual Fund Taxation FY 2021-22 / AY 2022-23 | Capital Gain Tax Rates”? Many may argue that Gilt Funds since few years generating fantastic returns of around 10% to 12%. However, these are pre-tax returns at first and the second aspect is that they generated fantastic returns mainly because of the downtrend in the interest rate market. What if the trend reverse??
However, there may be few instruments like PPF which may be offering higher tax-free returns than the EPF post-tax returns on the amount which is taxable as per the new tax rule. Calm down….let us move to the second important point.
# Interest on this additional amount is not taxable from subsequent years
One more important point mentioned during the Budget 2021 is that “provisions of these clauses shall not apply to the interest income accrued during the previous year in the account of the person to the extent it relates to the amount or the aggregate of amounts of the contribution made by the person exceeding two lakh and fifty thousand rupees in a previous year in that fund, on or after 1 st April 2021, computed in such manner as may be prescribed.“.
It means, the EPF of what you contributed in the year (on which you are forced to pay the tax) if we take the example of above of Rs.1,50,000 and interest of Rs.12,750 in total to be considered as a principal for the next year compounding (Rs.1,62,750). Interest on this Rs.1,62750 is tax-free from subsequent years.
Hence, this new taxation is applicable only for the year where you contributed more than Rs.2.50,000. From the second year onwards, any interest you earn from this is COMPLETELY TAX-FREE.
Do you think it is wise to earn 5.9% on first year and from second year again 8.5% as usual than experimenting with some other products??
Conclusion:-Considering the current interest rate scenario, even though the Government disheartened many by imposing this tax, we think we look into the investment options available and the subsequent years tax treatment offered to us, EPF is still the best option for your debt part of retirement goal.