All you need to know about EPF

What is it, why is it and why does the government want it?

WrittenBy:Aman Malik
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On Tuesday, after much pressure and violent protests, the government announced it had rolled back its February 10 order, making it tough for people to prematurely withdraw money from their Employee Provident Fund (EPF) before they retire. This is the second time in the last two months that the government has had to go back on a proposal concerning the EPF, which offers the only credible social security mechanisms to the salaried class in the country and is therefore, quite literally, central to how middle-class India saves and invests its hard-earned money. It also seems to be one of the least-understood financial terms, so here’s a quick explainer on what the EPF is and where it stands now.

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What is the Employee Provident Fund (EPF), and how does it work?

EPF is essentially a contributory retirement savings scheme, intended to provide a minimum amount of social security to retirees, irrespective of whether they are entitled to a pension or not.  Apart from the employee himself, the employer too is required to compulsorily contribute to the former’s EPF account. Both parties contribute 12% each of the basic salary of the employee to the fund. In other words, if the monthly basic salary of the employee is Rs 10,000, the employer would contribute Rs 1,200 and a similar amount would be deducted from the latter’s monthly pay-out to be deposited with the Employees’ Pension Fund Organisation (EPFO), a wing of the Union labour ministry, which manages the EPF.

However, there’s a catch. Out of the 12% that the employer contributes, only a third (3.67%) is actually directly put into the EPF account itself. The other portion (8.33%) goes into an Employees’ Pension Scheme.

On top of these mandatory contributions, employees can choose to contribute voluntarily. Many of them do since, it offers long-term, tax free and risk free returns. At present,more than four crore people have EPF accounts, which adds up to a whopping Rs 8.5 trillion under management.

Why is the EPF an emotive issue for the Indian salaried class?

Unlike in the US or other wealthy countries, India does not provide its retirees, especially those who were privately employed or self-employed, any definitive form of social security in their twilight years. Only those people who have retired after serving a minimum number of years in the defence or paramilitary forces or various government departments are entitled to a lifelong pension.

In other words, once non-pensioners retire, they are entirely dependent on returns from their own savings. This is where instruments like the EPF become important, since they ensure that salaried employees have to compulsorily put away a certain portion of their monthly incomes as contribution towards what would eventually become an important portion of their retirement corpus. And it is precisely for this reason that the salaried class guards its savings (like the EPF) zealously, and wants the government to keep its hands off it.

So, what exactly did the February 10 notification say?

On February 10, the labour ministry, which essentially controls the EPF, changed the rules that pertain to withdrawal of money. The new rules said that employees could only withdraw their portion of the contribution, and not that of the employer’s, till retirement. In other words, the 3.67% that your employer puts in, could not be withdrawn before you turned 58. Before this notification, people could withdraw the entire contribution (apart from the 8.33% going towards the Employees’ Pension Scheme, in case of medical exigencies, to fund their children’s education or marriages, buying a house or a plot of land, repayment of home loan or repairing or altering your home.

But why did the government restrict these withdrawals?

The government said it had good intent behind the move: it wanted people to save till their old age and not use up their savings before they retired. A labor ministry statement said that its “objective was to provide minimum social security to workers at the time of retirement.” The government said that as many as 80 percent of the people were withdrawing money from  their EPF accounts prematurely, “treating the EPF accounts as savings accounts, and not a Social Security instrument.”

Wasn’t the government going to tax my EPF returns? What happened to that?

Like we said, Tuesday’s rollback is the second time the government has had to sheepishly walk away from an EPF-related proposal that would have hurt the salaried classes. In his budget speech on February 29 this year, Finance Minister Arun Jaitley had proposed that 60% of interest accrued on contributions made after April 1, 2016 would be taxed, while 40% would remain tax-exempt. To be sure, the principal amount (that is, the contributions themselves) were not being taxed, so the impact would have been limited, but an overall negative sentiment (after much confusion over whether the principal amount would be taxed or not), forced the government to back-off and withdraw the proposal on March 8.

As mentioned earlier, since it offers tax free, risk free returns, EPF has been an extremely popular long-term investment vehicle, with millions of subscribers choosing to contribute voluntarily. So, when people saw the government eyeing a pie out of their nest egg, they reacted sharply.

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