Last Updated on February 4, 2021 at 3:02 pm
From 1st April 2021 onwards, the interest on any contribution above Rs. 2.5 lakh by an employee to a recognised provident fund is taxable as per the provisions of the Finance bill 2021. Here is a simple illustration of how the tax works: How employee contributions over 2.5 lakhs get taxed like an FD. Many have asked if this rule applies to PPF. It does not because you can only invest 1.5 lakh in PPF.
Update 1: Find out taxable EPF Interest with this calculator
Update 2: The Central Board of Direct Taxes has now confirmed that the interest is taxable every year
Case 1: Now if your mandatory PF contribution is more than 2.5 lakh a year, there is not much that you can do. The tax will automatically apply to the interest from contributions above Rs. 2.5 lakh.
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Case 2: If your mandatory PF contribution is more than 2.5 lakh a year and your employer is offering NPS, request (if options are not already available) them to divert part of employee contribution to NPS. The split between EPF and NPS employee contributions is up to your comfort level. Set NPS asset allocation to gilts plus corporate bonds and invest in equity elsewhere.
Case 3: Mandatory PF contribution is less than 2.5 lakh but voluntary contributions (VPF) make the total contribution above Rs. 2.5 lakh. If your employer is offering NPS, you can do the same as mentioned in case 2. If not, you can consider shifting the VPF contributions to a gilt mutual fund (assuming this is a long-term goal).
Note: Gilt mutual funds (like NPS) are market-linked instruments. So please appreciate the risks before investing. This is a related discussion: Why I partially switched from ICICI Multi-Asset Fund to ICICI Gilt Fund
A tax-free instrument with unlimited contribution is simply too good to last forever. At least for those with EPF, the rates should typically be higher than PPF and over the next decade should be higher a bank FD. So taxable EPF( above 2.5L) is still relatively a good deal.
If you want to avoid this taxation, then you will have to embrace market risk via gilts funds or NPS. With some education and experience, this is eminently achievable provided expectations are low and notions of “safety” redefined.
Gilt funds with capital gain based taxation with inflation indexation will be beneficial to those in the 30% and 20% slabs. Also see: PPF vs Gilt mutual funds: Which has done better over 15 years? and Can we invest via SIP in gilt mutual funds for the long term? and Can we get better returns by timing entry & exit from gilt mutual funds?