Sheen diminished for VPF, but not lost: Here's how should you invest?

Only PPF and Sukanya Samriddhi offer higher returns among govt-backed schemes

In the Budget for 2021-22, interest earned on contributions of above Rs 2.5 lakh a year to provident funds was made taxable. While post-tax returns from Employee Provident Fund (EPF) or Voluntary Provident Fund (VPF) contributions of above Rs 2.5 lakh will reduce, they still remain attractive compared to most other fixed-income instruments.

Better than most other govt schemes

Up to Rs 2.5 lakh, employees will continue earning tax-free returns of 8.5 per cent. For contributions exceeding this amount, a person in the 30 per cent tax slab will earn a post-tax return of 5.85 per cent.

Only one government-backed instrument (open to all investors) gives returns higher than 5.85 per cent — the Public Provident Fund or PPF, which gives a 7.1 per cent return (tax-free).

The Sukanya Samriddhi Account (SSA) also offers a higher return of 7.6 per cent, which is tax-free on maturity. However, this is open only to people who have a girl child aged below 10 years.

Interest income from other government-backed instruments such as Senior Citizens Savings Scheme (pre-tax return 7.4 per cent), RBI Bonds (7.15 per cent), Kisan Vikas Patra (6.9 per cent), and National Savings Certificates (6.8 per cent) are all lower on both pre- and post-tax basis.

How should you invest?

Suppose that your annual contribution to EPF is below Rs 2.5 lakh. “Subtract your mandatory contribution to EPF from Rs 2.5 lakh. Whatever is the amount, contribute that to VPF so that your total contribution adds up to Rs 2.5 lakh. After this, exhaust the Rs 1.5-lakh limit in PPF,” says investment and tax expert Balwant Jain. You will thus earn 8.5 per cent on your investment of Rs 2.5 lakh and 7.1 per cent on the next Rs 1.5 lakh. Hereafter, if you like (and if your liquidity requirements permit), you may invest more in VPF. 

Any amount you contribute now will earn you a post-tax return of 5.8 per cent (30 per cent tax bracket).

PPF vs VPF

Besides return, how do these instruments compare on other parameters? Once PPF’s 15-year tenure ends, you can keep extending it in blocks of five years. After the 15-year tenure, partial withdrawal is permitted: 60 per cent of the balance at the time of extension can be withdrawn over the next five years, with one withdrawal permitted each year. On the flip side, as Jain points out, you can invest only up to Rs 1.5 lakh a year in PPF.

Your provident fund account will not be with you for your lifetime. It will become inoperative and stop earning interest three years after retirement.

Other options you may consider

Another retirement product you may consider is National Pension System (NPS). Its returns can be attractive (but not fixed) due to the equity component of investment and low charges. Mrin Agarwal, financial educator and director, Finsafe India says, “You also get a deduction of Rs 50,000 under Section 80CCD (1B), over and above Rs 1.5 lakh under Section 80C.”

Those looking for an option where returns are not fixed, but which offers liquidity, may consider shorter-duration debt funds. “If you invest for more than three years and avail of indexation benefit, your post-tax return could be similar to that of VPF,” says Sanjeev Govila, Sebi-registered investment advisor and chief executive officer, Hum Fauji Initiatives, a financial planning firm.

No retrospective application

Finally, one aspect needs to be clarified. News reports have suggested that this new rule—provident fund contributions above Rs 2.5 lakh to be taxed at slab rate—could also be applied retrospectively. Central Board of Direct Taxes (CBDT) chairman P C Mody told Business Standard that there would be no retrospective application.