EPF, PPF interest rate gap widens to 105 basis points: Self-employed class disadvantaged

Yesterday's cut in Public Provident Fund's (PPF) interest rate to 7.6 percent increases the gap between this and the Employees' Provident Fund (EPF) rate to a huge 105 basis points (bps).

Even if the EPF rate for FY2017-18 is marginally cut from the current 8.65 percent to, say, 8.4 percent, the difference would remain substantial thereby disadvantaging the self-employed class in terms of retirement savings.

Even while the yield on government securities (G-secs) has been rising over the last 1-2 months, the government has cut interest rates for the January-March quarter of 2018 on almost all small savings products except for the Senior Citizen Savings' Scheme.

The interest rate on PPF was 7.8 percent in the previous quarter. The government resets the interest rate on small savings every quarter. Interestingly, EPF another retirement focussed savings instrument currently offers a higher rate of 8.65 percent (2016-17), a difference of 105 basis points.

EPF is an instrument that is available only to a salaried individual, while PPF can be used by all including salaried, professionals, home-makers, self-employed, and even those who are not part of the workforce. The humble PPF has also been a favourite among several parents who open accounts in the name of their minor children so as to accumulate savings for their long-term needs.


Will EPF rate be cut?
For the financial year 2017-18, the government is yet to announce the rate on EPF and it remains to be seen by how much it will be cut. The finance ministry has been nudging the labour ministry to align the EPF rate with small saving schemes like PPF. "Employees Provident Fund Organisation may cut rate of return on provident fund deposits for 2017-18 due to lower income on bonds and its plan to credit ETF investments directly into the account of subscribers," a senior labour ministry official had said earlier.

Let us say, the EPF rate is cut by 20 basis points for 2017-18, the gap between EPF and PPF would still remain a wide 0.85 percent even if the PPF rate is maintained over the next 12 months. While pressure to cut EPF has therefore increased, the EPF interest rate setting is substantially influenced by political considerations. So, even if there is a cut in EPF interest rate, it would take some time before the difference in rates between PPF and EPF narrows down substantially.

How is EPF rate set?
The EPF interest rate doesn't rely much on G-Sec yields. However, the EPFO earns its income primarily from G-secs. Currently, 15 percent of EPF contribution by the employee is invested by EPFO in equities through the exchange-traded funds and 85 percent in debt instruments like government securities.

The setting of EPF rate is, therefore, not directly dependent on G-Sec yields. The decision is based on how much has been earned by investing the EPF corpus in a financial year. The interest rate on EPF is administered by the Ministry of Labour and Employment on the recommendations of the Central Board of Trustees (CBT). The finance ministry finally ratifies the interest rate. Generally, whatever is earned is distributed to employees, although any surplus is retained for future distribution.

PPF may still rule
The PPF earns tax-free interest, thus making the maturity amount tax-exempt in the year of exit. While partial withdrawals are allowed from the seventh year, the entire PPF corpus can be withdrawn after 15 years. The PPF can even be extended indefinitely in a block of 5 years with or without contributing any further during the extended period.

Rather than just looking at the nominal rate of 7.6 percent of PPF, consider the effective rate of interest based on one's tax rate. It translates to 11 percent of taxable investment for someone in the highest tax bracket. With hardly any taxable instrument earning a return of 11 percent which come with safety and assurance, the PPF still rules the roost when it comes to investing. Therefore, a portion of your savings can still be invested in it.