Voluntary Providend Fund: Whether to opt in or opt out?

Employees' provident fund, or commonly known as a provident fund, is a mandatory retirement savings avenue managed by the government. It is a statutory body established by the Employees' Provident Fund and Miscellaneous Provisions Act, 1952 and is under the administrative control of the Ministry of Labour and Employment, Government of India.

It is a systematic mechanism applicable to salaried employees wherein a percentage of the employee's salary is deducted and transferred to his provident fund account. The same amount is contributed by the employer towards the employee's provident fund account. This is done on a monthly basis. The amount gets accumulated, and the interest is accrued yearly.

This fund usually forms a part of the employee's retirement benefits. The employee is entitled to withdraw both principal and interest at the time of his retirement.

In India, 12% of basic salary (basic salary + dearness allowance) must be mandatorily contributed towards provident fund by any employee working in an organisation comprising more than 20 employees. The employer also contributes an equal amount.

Voluntary Provident Fund 

It is an extended version of the Employees' provident fund scheme. If an employee wishes to contribute any amount in excess of the mandatory percentage, such a contribution would constitute what can be referred to as a Voluntary provident fund. There is no ceiling limit to how much an employee can contribute towards VPF.

Basic rules for VPF:

• Only salaried employees enrolled in the employees' provident fund are eligible for voluntary provident fund schemes.
• Employees in the unorganised sector or self-employed individuals are not eligible to contribute towards VPF.
• Once an employee chooses VPF, he cannot withdraw or opt-out in the middle of a year.
• The accrued interests on the balance as well as the maturity amount are free from wealth taxes.
• There is no maximum limit for the contribution. An employee is free to contribute as much as 100% of his salary. However, the employer might choose to adhere to the mandated amount.
• There is a lock-in period of 5 years, during which the amount cannot be withdrawn. If, due to any circumstance, the amount is withdrawn, the employee is obliged to pay tax on the interest amount earned on his contribution towards VPF.
• One can withdraw from accumulated savings of VPF contributions if he or she is unemployed for more than two months or when they retire.

The contribution made towards the voluntary provident fund is eligible for deduction under section 80C of the Income Tax Act. Any amount of contribution made by the employee is deductible from his gross total income to the extent of Rs.1,50,000. 

The interest earned on such a VPF scheme is similar to that earned on a regular employees' provident fund, which is currently 8.5% per annum. The government assesses and revises this rate of interest every year. 

Benefits of VPF

• The process of contributing towards a voluntary provident fund is very simple. The employee has to only inform the employer regarding the amount he wishes to contribute. The employer will deduct the said amount every month and transfer it to the fund.
• The risk associated with voluntary provident fund schemes or even EPF is negligible. As it is owned and managed by the government, it is one of the safest avenues to invest in.
• Another advantage is that if the employee chooses to change his job, the employees' provident fund account and the balance can be easily transferred. The employee has to intimate his new employer about his preference for the voluntary provident fund. 

Interest rates on VPF contribution

It can clearly be observed that the interests have been quite steady for the past 20 years. Also, when compared, interest rates in VPF is higher than bank FD, which currently offers around 5% and public provident fund, which currently offers 7.10%. 

Interest on a voluntary provident fund scheme is calculated monthly. The opening balance of every month is considered to calculate the interest. The cumulative interest for a year is, however, credited only at the end of the year. 

The contribution is made at the end of every month. Therefore, the opening balance for the first month would be nil.

The standard contribution is 12% of salary by both an employee and an employer. The employer contribution of 12% is bifurcated - 8.33% toward Employees' Pension Scheme (EPS), 3.67% toward EPF, and 0.5% toward Employees Deposit Linked Scheme. However, this structure is only applicable to the wage ceiling of Rs.15000. When one's salary exceeds that wage ceiling, employers can choose to:

1. Pay 12% of basic pay minus 8.33% of Rs.15000 as an employer contribution to EPF.
2. 3.67% of Rs.15000.

The interest on VPF is based on the opening balance in EPF accounts. Therefore, the employer contribution is a crucial element to be considered.

Let's take an example to understand the computation of interest.

Ashok joins an organisation M/s. Kapoor and associates on 1st April 2019. His salary was fixed at Rs. 50,000. He wishes to contribute 8% in addition to the statutory requirement of 12% towards VPF. His employer pays 3.67% of Rs.15000 as a contribution to Ashok's EPF account. The VPF interest rate in 2020 is 8.5% per annum. 

The opening balance in April would be nil. Hence, no interest would accrue. For the month of May, the opening balance would be calculated as (20% x 50000) + (3.67% x 15000), which would sum up to Rs. 10,550, on which interest @8.5% p.a would give Rs.75. For the month of June, the opening balance would be Rs.21,180, for which the interest accrued would amount to Rs. 150. Subsequently, interest would be calculated for each month.

Final words

There are a number of investment avenues out there. But each of them requires your time and research for better decision making. However, not everyone can allot that much time, and not everyone has the research prowess necessary for evaluation. Hence, a Voluntary provident fund is one of the safest, easiest and high return earning investment avenues an individual can opt for when he doesn't wish to dive into the complexities of the other enormous investment opportunities available.

Well, what do you think about VPF? Tell us in the comments below.