EPF scheme is mandatory for the employees. There is no competition. Still, it gives best interest rate among all the saving schemes. It happens because EPF scheme is managed by the government and it tries to keep interest rate maximum. In the future, you may expect a higher earning from EPFO as some of your EPF contributions is also invested in the share market.
Latest EPF Interest Rate
The latest interest rate of EPF scheme is 8.55%. This rate is applicable for the financial year 2017-18. The EPFO revises interest rate every year. Thus, you don’t know the future earning from the EPF account.
I have told you the interest rate of FY 2017-18. So, you may have apprehension, whether this interest rate is latest or not. In fact, your thinking is right as we normally want to know the interest rate of coming period. All other savings schemes tell interest rate in advance. We know the PPF interest rate of coming quarter before it begins.
But, EPF scheme has a different approach. It tells you the interest rate when a financial year nears to the end. Such as, the interest rate for FY 2018-19 would be declared in Feb-March 2019. Sometimes. It is declared in the month of the April or May.
How PF Interest Rate is Fixed
The EPFO manages the corpus of EPF scheme. It invests the collected amount mostly in the government bonds. The government bonds are bought for a long-term and these give a fixed return. The EPFO declares the interest rate for an outgoing financial year as per its earning of the year. It does not take risk of advance estimates.
The EPFO board decides the interest rate with the consultation of the finance ministry. Sometimes, the government may not cut the interest rate because of the political compulsion. There is strong labour lobby which opposes any decrease in the interest rate. That is why the EPF interest rate is about 1% higher than the PPF. Whereas both of these schemes invest in government securities.
Meanwhile, EPFO has started to invest in equity ETF. These ETFs invest money into the shares of big companies. However, the return of these shares is not predictable. Neither EPFO can sell these shares according to a timetable. Hence, EPFO now gives units for the ETF investment. The EPF member gets ETF units in proportion to their contribution. Becasue of this arrangement, any rise or decline in share price would immediately impact the value of your holding.
EPF interest calculation
In the EPF scheme, you and your employer contribute every month. Your full 12% contribution goes to the EPF scheme. While employer’s 8.33% contribution (maximum ₹1250) goes to the pension scheme. The remaining amount goes to the EPF scheme. The EPFO does not give any interest on the pension corpus. The interest is calculated on EPF corpus.
Since EPF contribution is given monthly, the interest is also calculated for every month’s contribution. Hence, the monthly interest rate is used to get interest of each month. You can know monthly interest rate by dividing annual interest by 12.
Every month, the interest is given on the opening balance of the EPF account. Thus, any contribution after the last day of the previous month would not become part of the opening balance. For example, if you contribute X amount on 2nd april, this X would not get any interest for the April month. The interest on x would be calculated in the next month.
The compounding of EPF interest happens at the end of every financial year. On 31st March of every year, the interest is included in the EPF balance. After this addition, you get the interest on interest.
Example of EPF Interest Calculation
To understand the EPF interest calculation, you should go through the following chart. It is a sample interest calculation of ₹ 5000/month contribution. Since the first contribution start from the 5th April, the interest on this amount would be zero in the month of April. This amount would earn interest next month.
On the 31st March, your total contribution balance would be 60,000 and interest-earning would be 2379. Both of these amounts would be added. It would become the opening balance for the next month i. e. April 2017.
EPF Interest vs Others
The EPF scheme gives highest interest rate among all the fixed rate schemes. Although EPFO announces interest rate at the end of the year, the rate has been constantly better than the PPF, NSC or any other tax saving schemes. ELSS and NPS may give a higher return but it happens because of the investment in share market. You know that share market is risky, There may be some negative return as well. In the following chart the return of ELSS, NPS and Insurance is estimated as per the past experience.
How To Take benefit of EPFO’s high Interest
Now, you know that EPF is best tax saving scheme which gives an assured return. However, this scheme is available only to the employee.
An EPF member has the option to enjoy the greater benefit. You would be aware that EPF contribution is fixed percentage of your salary. However, if you wish, you can contribute more than the fixed 12%.
There is a facility of voluntary Provident Fund (VPF). In this facility, you can increase your contribution up to your basic salary. The VPF can be useful in following ways.
- It gives higher interest than PPF, NSC, tax saving FD and traditional insurance policies.
- You can use the extra contribution for tax deduction under section 80C.
- You can build a bigger retirement corpus. The maturity amount would be tax-free.
Interest on Inoperative Account
There is a common confusion about the interest on the inoperative account. People still think that the EPFO would stop giving interest if there is no contribution to EPF account. However, this rule has been abolished.
In fact about 10 years ago the government made the rule of inoperative account. According to this rule, if there is no contribution in an EPF account for 3 years, it would become inoperative. Further, the EPF would not give any interest on such accounts.
But, now this rule is scrapped. Your account would never be inoperative. It would keep earning interest until the retirement.
Tax on EPFO Interest Earning
The EPF scheme gives you all round tax benefit. It has 4 types of tax benefit.
- Your contribution to EPF scheme is eligible for tax deduction under section 80C.
- The employer’s contribution is exempted from tax under section 10(11) and 10(12) of the income tax act.
- The interest earning of EPF account is also exempted from the tax.
- There is no tax on maturity amount. It is 100% exempted.
Thus, EPF scheme is one of the few saving schemes which do not charge any tax on the interest earning. Whereas, the NPS earning is not 100% exempted from the tax.