Savings in India: proposed changes to Provident Fund (PF)

If the draft guidelines issued by the government last month take effect, private provident funds will have more flexibility in how they can invest the funds at their disposal.

A summary of the key changes proposed in the guidelines:

• Amount that may be invested in shares of companies listed on the BSE or NSE (subject to being rated “investment grade” by at least one agency) or in Equity Linked Savings Schemes of mutual funds to go up to 10% of total funds, from 5% previously
• 25% of total funds may be invested in deposits of private sector Banks that fulfil capital adequacy and net worth criteria
• Trustees are allowed to decide if a further 30% is to be invested in money market funds, bank deposits or public sector bonds
• Requirement of investment in Central and State Government securities or mutual funds where the underlying assets are such securities, to be reduced.

Should these guidelines be passed, this retirement planning option could yield higher returns. While this is a welcome development, people must realise that the primary objective of a provident fund is to provide sustenance during retirement. Unfortunately, a lot of people withdraw these funds to meet large or unexpected expenses. By doing so, they forgo several benefits:

• When the provident fund in someone’s account completes 5 years (with a single employer or otherwise), the withdrawal becomes tax free. In contrast, early withdrawal requires that the employee pay tax on his or her entire contribution
• The Employee Provident Fund pays a tax free interest of 8.5%, which is attractive compared to many other instruments
• Once can still meet exigencies while not liquidating the corpus since there is a provision that allows the account holder to withdraw funds under specific circumstances, such as medical emergencies or construction of a home.

The provident fund is intended for retirement. As far as possible, it must be protected for this use.