Last Updated on January 21, 2022 at 8:49 pm
How should funds in EPF be handled If we wish to quit our job and become self-employed or resign a few years before normal retirement or wish to retire earlier? Should we leave the EPF funds as is or should we withdraw? If we withdraw what are the alternative investment options?
About the author: Sriram Jayaraman is a SEBI registered fee-only Investment adviser. After 27 years of working in large IT companies in India, he achieved financial independence and retired early to become a fee-only advisor. You can contact Sriram via his website arthagyan.com. Previous article by Sriram: How to use MF, stock losses to reduce your tax burden (tax-loss harvesting) and 11 Investment mistakes newbies should avoid in 2020!
This article stems from a question by Gunesh Apte, who wanted to know where to invest such withdrawn EPF funds. Sriram will discuss withdrawing from EPF vs staying invested (in case of early retirement) in this article and discuss alternative options in detail in the second part. Regulars reader may be aware that he has already written about a similar topic: How should senior citizens invest in 2020.
Let us first understand the basics. EPF is Employee provident fund. This is managed by Employee Provident Fund Organization (EPFO) which falls under the Ministry of Labour & Employment of the Government of India. It was formed by the EPF Act in 1952. The objective of EPFO is to enable employees of the organized sector to save for life after retirement. The employee contributes 12% of salary (basic + dearness allowance) and the employer contributes a matching amount towards EPF.
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The breakup of the employer contribution is 8.33% with a cap of Rs. 1,250 is towards EPS (Employee pension scheme) and the rest goes into the EPF kitty. The EPF interest rate is decided by the Govt of India together with the Central Board of Trustees (CBT). There is no interest on the EPS contribution. The EPF can be withdrawn by the employee when the employee retires or is not in employment for a minimum period of 2 months or if the employee moves abroad or when the employee is dead.
The EPS needs to be withdrawn if the employee has not completed 10 years of service. EPS cannot be withdrawn on completion of 10 years of services, instead, a pension is payable to the EPS account holder after 58 years of age. There are rules on how the pension is calculated. The EPS is designed for low-income earners. EPS pension could at best be pocket money for high-income earners. EPF is managed by Trusts under directives from EPFO.
There are several Private trusts which manage EPF money of employees of large organizations. There are specific rules which need to be followed by the private EPF Trusts regarding instruments to be invested in. The interest needs to be paid as per the directive from EPFO.
Why is EPF a very attractive long term savings option? EPF falls under the EEE category of investment. The first E stands for exemption from income tax under section 80C up to Rs. 1,50,000 per annum. The second E stand for exemption from income tax for the interest credited to the EPF account every year.
The third E stand for exemption from income tax at withdrawal (after completion of 5 years of contributions). The interest rate paid on EPF is normally higher than Fixed deposit interest rates. This EEE treatment for EPF makes it a very attractive option for the debt portion of your savings.
The tax-free status of EPF is however only applicable when you are working and contributing. Once you quit working, the interest earned is taxable. There is a judgement from ITAT (Income Tax Appellate Tribunal) which ruled that any interest credited to EPF account post-retirement of an employee is taxable in the year that it was received.
Should you withdraw your EPF after quitting your full time job? Now it is clear that EPF is taxable once you quit your job to either to start a business or for retirement. The interest offered by EPF is 8.5% for the last year. The current year may be lower than this. However, it is still much higher than the Fixed deposit interest offered by PSU banks and large private banks. You can consider to hold the EPF even if it is taxable.
When will my EPF account become inoperative? The EPF rules say that the interest will not be credited from the date on which it has become “Inoperative”. So it is significant to understand the rules when an account becomes inoperative. This is the official EPF scheme documentation.
The provisions of subparagraph 6 of paragraph 72 gives these rules. This can be found on page 80/81 of the scheme documentation. I find this to be quite unclear. Maybe you can read it and understand it better! I understand the below:
- For a person who retires from service after attaining the age of 55, he/she has a period of 36 months to withdraw the balance
- For a person who has migrated abroad permanently, there is a period of 36 months to withdraw the balance.
- For a deceased person, his/her family has a period of 36 months to withdraw the balance
- There is no mention of a person who has retired before the age of 55. So it is not clear from the scheme document how the EPFO operations will differentiate between a person who has migrated abroad, a person who is deceased and a person who has quit his/her job before the age of 55. All the EPFO operations will know is that the person has stopped contributing to the account. There is no way EPFO operation can know this when you have not informed them.
- There is another twist to this. A document downloaded from the EPF portal says (page 5), “So members who are leaving service before 55 years of age should file claims maximum by the age of 58 years to not lose any interest. Members who have retired after 55 years of age should file claim maximum within the next three years.”
- This clearly says that for anyone quitting job before the age of 55, can withdraw the balance before age of 58, he/she will receive all the interest till withdrawal
Takeaway: After you quit your full-time job, you get 36 months to withdraw your balance. During this period, the interest will be paid and it will be taxable. You can choose to withdraw it 2 months after quitting your job as well; it is your choice. After 36 months, if the account becomes “inoperative” and interest is not credited, then you can follow-up with an email to [email protected]. If you are informed that your account is now “inoperative”, then you should file a claim and withdraw your EPF balance.
Acknowledgement: Thanks to Srikanth Reddy article on this issue.
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