EPF or PPF? – Implications of EPF rate hike to 9.5%

The Central Board of Trustees, Employees Provident Fund (EPF) have recommended an interest rate of 9.5% on EPF for the financial year 2010-11 as against 8.5% which was prevalent for last five years.

The question is whether this rate will be sustainable? Most probably no.

The fund will be achieving return in the range of 8.5% from its corpus and the additional outgo of Rs. 1,600 crores on account of the rate hike of 1.0% will be met by ‘hidden surplus’ cash of Rs. 1,700 crores which was discovered after a comprehensive analysis of EPF scheme’s accounts since its inception. Hence this entire amount will vanish after this year’s interest payout.

Second, a news report says that Company-managed PF trusts, which are required to match the rate declared by EPF, are not happy with this rate hike, since they find it difficult to earn more than 8% and employers will have to contribute additional funds to maintain the interest payout.

Third, the trustees have not yet decided on investing part of the corpus in capital market, which will enable them to achieve higher returns.

All this signals that, unless the trustees agree to park part of the corpus in capital market, it will difficult for them to sustain interest rate of more than 8.5%. Thus this rate hike of 1% will be purely one-time on account of discovering the ‘hidden surplus’ cash.

Which fund gives better returns - EPF or PPF?

Public Provident Fund (PPF), in which any individual can invest up to Rs 70,000 p.a., gives tax-free return of 8%. Now comparing that with EPF tax-free return of 9.5% for this year, it makes sense for salaried employees to contribute more (beyond the mandatory 12% of Basic + DA) to their EPF rather than in PPF for this year. So start pumping more to your EPF through voluntary contribution for this year rather than investing in PPF.

One interesting thing to note is historically the rate of EPF has generally been more than PPF.

Interest Rate Comparison

The above chart shows that most of the time the difference is of 50 basis points where as in some years, the gap widens to as much as 150 basis points. One basis point is one-hundredth of a percentage point. This can make substantial difference in a long run. Hence it seems to be beneficial to invest in EPF more rather than in PPF for retirement savings.  Here retirement savings is important, since tenure of EPF is till retirement, whereas tenure of PPF is for 15 years.

In other announcements, the Trustees have decided to hike the benefit under Deposit Linked Insurance Scheme from present maximum limit of Rs. 1,00,000 to Rs. 1,30,000. This is payable to family of employees who die while in service. It will be calculated at 20 times average monthly wages drawn in preceding 12 months, subject to the cap of Rs. 1,30,000. 

The trustees have also decided to close “inoperative accounts” (no activity in preceding 36 months) and no interest would be credited to such accounts. The number of such accounts is approx. 3 crores.