Will EPFO hold you hostage?

EPFO should let the subscribers decide how they want to invest and also allow the government to tax early withdrawals

Recent reports suggest that the Employees Provident Fund Organisation (EPFO) is planning a series of steps, or should I say missteps, to stem the tide of premature withdrawals from the fund.

At present, subscribers are allowed to withdraw their full provident fund savings after two months of quitting their jobs. Partial withdrawals are allowed in the case of factory closure, marriage, higher education of children or for medical needs.

However, it seems the EPF authorities feel that large numbers of premature withdrawals are adversely impacting the social security of the member and his family. They are proposing allowing only partial withdrawal, even in the case of loss of a job. The balance will be allowed only at the time of retirement. It’s not a new thought. The EPF has tried imposing such curbs earlier only to be met with violent protests. 

Globally, governments use the carrot-and-stick approach to encourage investments for retirement. Carrots are in the form of tax breaks both while investing and withdrawals. But they are applicable only if the withdrawal is made after reaching the age of retirement. An additional incentive is providing control to the investor, concerning where his funds are invested. The stick is in the form of heavy taxation on premature withdrawal. 

In India, the carrot is in the form of tax breaks on investments. There is no stick if the money is withdrawn after five years. And of course, in the grand old tradition of the mai-baap sarkar, subscribers have no control whatsoever. 

If subscribers are withdrawing early, the response of the mai-baap administration is ‘ban the early withdrawals’. No effort is made to find out why the subscribers want to withdraw early. It is almost like an autocratic parent wondering why his child wants to leave home when all comforts are provided at home, and there is no rent. It never comes into the parent’s mind that the adult child seeks independence and that includes, the right to make mistakes. 

Going by this argument, the first thing that the EPFO needs to do is to cede control to those subscribers who want to take control. It should also stop resisting if the government taxes withdrawals made before retirement. In fact, it should recommend such a tax. But this will not work without the EPFO making the shift to allowing subscribers control over how their investments will be made.

Another issue is the taxability of the interest accrued on EPF after you have left your job. The language of the Income-Tax Act suggests that any interest accrued on EPF balance after you have left the job (and have not transferred it to another employer) will be taxable even if you do not withdraw it. In fact, according to this interpretation, the interest accrued even during the compulsory two-month waiting period is taxable. The EPF authorities can do well to get the air cleared around such a regressive interpretation.

Incentivising subscribers, on the one hand, coupled with taxation on withdrawal before maturity, is the only way to make sure that EPF subscribers are never referred to as ‘hostages’ by any finance minister in the future.

The author is a Sebi-registered investment advisor