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New PF Tax Rule: Should you cut your VPF contribution?

CA Sapna Ghelani 
Updated on 07 April 2021

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Finance Minister Nirmala Sitharaman has announced in the Union Budget 2021-22 to levy income tax on interest earned on employee's contribution towards the Employee Provident Fund, or EPF, if the sum is above Rs 2.5 lakh a year starting 1 April 2021.

This has created confusion amongst people regarding whether they should continue contributing towards a voluntary provident fund (VPF) that earns the same interest as that of EPF and enjoys the same tax treatment. Earlier the contributions were taxable and the interest earned thereon was exempt from tax.

Who can invest?

Voluntary Provident Fund is an extension of the Employees' Provident Fund (EPF).

Only those salaried employees who have an active EPF account and regularly contribute towards EPF can put money in VPF

New PF Tax Rule: Should you cut your VPF contribution

Is any change in your VPF investment strategy needed?

It is being said that those who invest heavily in VPF need to change their strategy after this rule has been changed in the Budget.

To know how much, we can invest in VPF without attracting tax on EPF interest, we need to reducethe mandatory contribution to EPF from Rs 2.5 lakhs.

Sudhakar Sethuraman, Partner, Deloitte India, said "Starting from April 1, 2021, interest earned on contributions made towards Employee Provident Fund (EPF) shall be taxable in the hands of the employee. Such interest is taxable provided the contributions are more than Rs 250,000 (Rs 500,000 where contributions are not made by Employer). In addition to EPF, it is common for individuals to contribute voluntarily towards PF (VPF). The limits for taxation as stated above, is determined after considering the aggregate of EPF and VPF contributions. It may be noted that the individual can still avail tax deduction subject to a ceiling of Rs 150,000 under section 80C on PF contributions. Considering this fact and the rate of interest the government offers, individuals can continue to contribute towards VPF."

 

As soon as total investment in EPF and VPF reaches Rs 2.5 lakh, go for PPF, where we will receive high interest than the post-tax return of EPF.

If we still want to invest more after exhausting the Rs 1.5 lakh PPF limit, then we can invest in VPF.

EPF comes with a guarantee so it is still the best-fixed investment option after PPF for high salary earners.

Even after being taxed at 30%, a person will earn interest at the rate of 5.95%, which is more than post tax returns of traditional instruments such as bank FD. Suppose a person is contributing Rs5 lakh towards EPF and VPF combined then the tax liability will be around Rs 6,375 (30% of 8.5% of (5 lakh minus 2.5 lakh)) for the year for the person in the highest tax bracket. Therefore, it will make sense to continue investing in VPF for long-term debt investments.

 

"For those in the higher tax bracket, VPF will remain a good option within the debt category," said Melvin Joseph, Sebi-registered investment adviser and founder, Finvin Financial Planners.


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