No more deductions, please

New EPFO circular will curtail your savings and borrowing ability

The Employees Provident Fund (EPF) is the biggest chunk of retirement kitty for most people. The Employees Provident Fund Organisation (EPFO) wants you to have more in that kitty by making the EPF deduction at 12 per cent of basic, dearness allowance and all allowances like medical, conveyance, education and others. At present, it is paid at 12 per cent of only basic and dearness allowance.

The intention is good, as the retirement kitty would be significantly bigger. Financial planners like Suresh Sadagopan argue that since EPF offers 8.25 per cent tax-free returns annually, a higher amount will be beneficial. In comparison, most debt instruments are taxed on the slab. So, any other comparable instrument will have to pay almost 12 per cent for similar tax-free returns.

But, a higher retirement kitty will come at the cost of a lower take-home salary – the key component that decides your savings, investment and, most importantly, borrowing ability when you apply for a home or car loan.

Typically, taxpayers in the highest bracket take-home around 65 per cent of their salary. Any additional cut will mean reduction of another 10-15 per cent, a significant amount. Assume one gets a basic of Rs 50,000 and other allowances contribute another Rs 50,000 to the monthly salary. For the sake of calculation. Let’s assume that the combined contribution of the employer and employee is 12 per cent or Rs 6,000. If the other allowances are added, the contribution will double to Rs 12,000. In that case, if the company’s contribution is taken separately from the salary, it will increase the salary to that effect. But since most companies add the employer’s part of EPF contribution to the cost-to-company (CTC), the salary is not likely to increase.

Says financial planner Arnav Pandya, “Companies will trim some salary components here and there to maintain the gross salary amount and divert the funds saved from trimming towards EPF.” In effect, the take-home will be hit. In cases where allowances are significantly higher, it will be hit more.

Importantly, this would be like ‘forced savings’ and does not allow the investors to take a call on the instruments they want to invest in. While EPF returns would be tough to beat by debt instruments, equities would beat these comfortably over the long run. For instance, Franklin India Balance Fund (growth option) has returned 13.56 per cent annually since its launch in 1999. Franklin India Bluechip (growth option) has returned 23.52 per cent a year since 1993. They are tax-free as well.

The worst hit will be purchasing power, especially in case of property. At present, banks lend 40-50 per cent of your take-home salary for home loans. If the take-home component were to fall by 10-15 per cent, the borrowing ability will also go down. In other words, buying a house will become more difficult. Anyway, the Reserve Bank of India has mandated that banks can lend only up to 80 per cent of the property price. This will be an added restriction on borrowing.

Guess employees can do without another cut in their purchasing power – the inflation (consumer price index) at almost 10 per cent is anyway hurting them badly. At best, it should be made voluntary.