What's the EPF rate cut impact? / Dec 23, 2005 / The Economic Times
From Indiapensions
What's the EPF rate cut impact?
ARNAV PANDYA
The drop in the interest rate of the Employees Provident Fund (EPF) from 9.5% to 8.5% for ‘05-06 has several implications for investors. All existing investors will be impacted by the change but for a complete analysis, this has to be considered from two different angles.
The first is the implication through the eyes of a person who has an existing investment and the second, is the role of future investment decisions for the provident fund account.
First, we shall consider the implications for existing investments. Here, one can again have two different classifications to figure out the impact on people. The first category consists of those people who have a large balance in their provident fund account.
The monetary impact on them will be higher because of the fall in rate, as the interest earned on the cumulative balance will be reduced. For every lakh as balance, the annual impact will be a Rs 1,000 reduction in interest. The actual calculation would be quite complicated because an amount is credited each month to the provident fund. In that sense, the impact for such an individual is slightly larger because the existing balance and the earnings are also impacted.
There are several people who have taken a loan or have other withdrawals against the provident fund and hence, the outstanding balance in their account is not very high. In such a case, the impact on such people will be lower. But this is no cause to rejoice, as this kind of low balance situation should not be happening since the investor is supposed to accumulate sums in the account for retirement purposes and hence, a draw down is not the ideal state of affairs.
On the other hand, another important factor is the period that remains till retirement. For those who are near retirement, the change in the rate will not have the same impact as those who have a long way to go. This has to be measured by looking at the time period available for further investments. While those nearing retirement might walk away with a high overall rate, the other factor to be considered is that they also do not have any time to cover up the fall in earnings.
In cases of individuals who are young and have enough time left till retirement, they should be relying on additional means of savings and investment for planning for their retired life. The provident fund account will be highly inadequate to sustain individuals in their old age, looking at the direction in which events are moving.
There is another factor that individuals still have to realise and this is that while the interest rate has been lowered, it is still slightly higher than most of the rates prevailing in other fixed income instruments. The entire gamut of small savings instruments, ranging from public provident fund (PPF) or postal monthly income plans or NSC provide a return of 8% and a yield slightly higher than 8%.
Once this is understood, the next step that one has to think about is with regard to the future and the kind of investment that has to go into the provident fund account. This is because there are two factors at work in the provident fund account. The first is the drop in rates while the second is also the impending arrival of the EET system of taxation.
The statutory part of the contribution of the individual will go automatically towards the provident fund and there is little that the investor can do about the figure here. However, they might have to take some action in case there is an additional voluntary payment because the attractiveness of this might undergo a change.
While the current financial year process can continue as scheduled, there will have to be a complete review in a few months’ time. Only after the actual details of the transition to the EET system is announced will the investor know the right way forward. One must also consider the fact that the interest rate could dip further in the future and at that time, there would be little that they could do about the extra funds committed for this purpose.
