Even at 8.65%, EPF rate is more atractive than most bank FDs

The Employees' Provident Fund Organisation (EPFO)'s decision to cut interest rate from 8.8 per cent to 8.65 per cent for 2016-17 should not come as a surprise to investors. With interest rates heading southwards, this move was expected.

Already, the yield on the government’s 10-year benchmark has slipped to 6.51 per cent. In addition, the small 10 per cent of the incremental corpus’ exposure to equities has not yielded great returns as the Bombay Stock Exchange Sensitive Index, or S&P Sensex, is up barely 3.3 per cent in the past year. Also, such a small exposure can barely offset overall returns.

"The rate of interest from EPF is still attractive compared to the rates on fixed deposits, National Savings Scheme, Public Provident Fund, and so on," says Rakesh Bhargava, director, Taxmann. If one considers the rate of return, which State Bank of India, the country’s largest lender, is offering, EPF rates look excellent. Sample this: SBI is offering seven per cent on its one-year fixed deposits and 6.5 per cent for five- to 10-year tenure. The gap between EPFO and SBI’s one-and 10-year rates currently stand at a good 165 and 205 basis points – something which will translate into a significant amount over the longer term.

If an investor puts Rs 10,000 a month in EPF at 8.65 per cent interest instead of 8.8 per cent, returns would be lower by only Rs 180 and even if this rate persists for the next 10 years, the difference would be merely Rs 3,822. In comparison, investing the same amount in a one-year SBI fixed deposit would fetch only Rs 8,400.

The Senior Citizens Saving Scheme (SCSS) gives a return of 8.5 per cent, which is taxable. The Public Provident Fund rate is also tax-free, but it has already come down to eight per cent. The falling interest on debt instruments has experts advising that people making voluntary contribution, over and above the compulsory deduction, should continue to do so. "Any person who makes an additional voluntary contribution, over and above the mandatory contribution of 12 per cent, should continue with that contribution at this point of time," says Manoj Nagpal, chief executive officer, Outlook Asia Capital.

If your employer gives the choice of investing either in EPF or National Pension Scheme (NPS), investors may consider shifting to the latter. The latter offers the potential to earn higher returns, since a higher proportion of the corpus can be invested in equities (as high as 75 per cent). However, the EET (exempt-exempt-taxation) status has played a spoilsport in case of NPS. "Also, a part of the final corpus will have to be invested in annuities." Returns from annuities are not very attractive. "If you decide to shift to NPS, choose a debt-to-equity ratio that is in keeping with your age and risk profile,” adds Nagpal.

Debt funds can be a good option. And, they have been a positive surprise this year as falling interest rates have given a spike to bond prices. For example: Gilt medium-and long-term and dynamic bond funds have returned 16.36 per cent and 14.07 per cent in the past year, respectively. Before you jump to invest aggressively in debt funds, remember that they are riskier in nature. If you planning to make fresh allocation to debt, debt funds are a good option.