Though it keeps a low profile, the Employees' Provident Fund is one of the most effective ways to save for retirement.

                                      

A recent survey by global professional services firm Towers Watson says that saving for retirement is a big concern for In dian employees, with 71% of the respondents worried that they are not saving enough. In another survey conducted by ET Wealth last year, respondents listed volatility of returns (32%), low savings rate (26%) and lack of reliable financial advice (25.4%) as their biggest retirement worry.

That's surprising, because a majority of the respondents of both surveys were already investing in a product that takes care of all these concerns. The Employees' Provident Fund (EPF) managed by the Employees' Provident Fund Organisation (EPFO) ensures that an individual puts away enough for retirement every month. With 12% of his basic salary and a matching contribution by his employer, a subscriber to the EPF should be able to accumulate a decent amount by the time he retires. If someone started working at the age of 25 in April 2000 at a basic salary of `20,000 a month and got a raise of 10% every year, he would roughly have accumulated `32 lakh in his PF account by now. If the trend continues, he would have saved about `2.46 crore by the time he is 55 years old (see graphic) and more than `3.5 crore of tax-free money on retirement at 58.

Despite the tremendous opportunity, most contributors to the EPF won't reach even the `1 crore milestone. More than 13% of the respondents to the ET Wealth survey withdrew their PF balance each time they changed jobs. Withdrawing from the PF can be counter-productive on two counts. One, the withdrawn amount is usually blown away on discretionary expenses and retirement savings are back to square one. Two, if the individual withdraws his PF balance before completing five years, the amount becomes taxable.

Another 20% of the respondents to our survey said they dipped into the PF corpus for other needs. The EPFO allows an individual to withdraw from his PF account for specific needs, such as constructing or buying a house, children's education and marriage or a medical emergency.

Should EPF invest in stocks?

The other concern about volatility of returns is also not an issue with the PF. The EPF invests in safe debt instruments that deliver stable returns. EPFO rules allow the EPF to invest up to 15% of its corpus in stocks but the Central Board of Trustees has steadfastly ignored suggestions to this effect.

Many financial experts, including Finance Ministry officials, have castigated the EPFO for this aversion to stocks. They say the EPF is a low-yield debt-based scheme that can never beat inflation. At a recent meeting of the EPFO, it was pointed out that the returns offered by the EPF since 2005, when adjusted to inflation during the period, were in the negative. The `100 put into the EPF in 2005, when marked to inflation, were worth only `97 now. Experts argue that the only way the EPF can beat inflation is by investing some portion of its gargantuan corpus in the stock markets.

And gargantuan it is. The EPF corpus was `6,32,129 crore as on 31 March 2013. If you factor in the interest earned by the corpus in 2013-14 and the estimated `80,000 crore in cremental contributions during the year, the EPF corpus could be close to `7,65,000 crore. This is almost six times the AUM of the largest mutual fund house (HDFC Mutual Fund with an AUM of `1,30,000 crore). Even if a 1% sliver of this gigantic corpus flows into the equity market, it would mean an inflow of `7,650 crore.

But while the inflow of fresh investments will be good for the equity markets, they may not have the same impact on investor returns. The New Pension Scheme (NPS) funds for central government workers are allowed to invest up to 15% of their corpus in Niftybased stocks in the same proportion as their weightage in the index. We looked at the SIP returns of these funds in the past 5-6 years and found that they were not significantly higher than what the 100% debt-based EPF has churned out. In fact, two of the funds have actually given lower returns (see graphic). This despite the fact that these funds have invested right through the bear phase of 2008-9 and the markets are at all time high levels right now.

Our calculations are not based on pointto-point returns but on SIP returns. We took into account the NAVs of the first reporting day of each month and then worked out the internal rate of return.

Don't shun equities altogether

Having said that, we must add that a certain portion of your retirement savings should certainly be allocated to equities. It's only that this equity exposure need not be through the EPF. Any retirement plan has to be a combination of several investments. Keep the EPF as the debt portion of your retirement plan and invest 5-20% in equities through a diversified fund.

Interestingly, though the pension fund managers of these NPS funds can invest up to 15% of the corpus in equities, they have allocated less than 8% to stocks. "Pension fund managers have been conservative because markets have been volatile. The negative impact of equity is magnified in the short term so they have shied away from maxing the equity exposure to 15%," says Manoj Nagpal, CEO of Mumbai-based wealth management firm Outlook Asia Capital.

On its part, the EPFO is now using professional fund managers for investing its corpus. "The move towards professional fund management and linking returns only from accrued income and reserves is a big positive," says Nagpal.

Compulsory and linked

The third concern about the lack of reliable advice is also laid to rest by the EPF. It is compulsory and an individual has no option but to contribute to it. What's more, it ensures regular savings. According to estimates by HR firms, the average hike this year was 10.5%. How much was your hike? More importantly, did you increase your SIPs by the same proportion? Not many people care to do that. They spend more, buy more, party more but keep investing the same amount.

The EPF is different. Your contribution is linked to your income, so when you get a pay hike, your EPF contribution will go up in the same proportion. If your basic salary is `30,000 a month, you will be contributing `3,600 plus a matching contribution by your employer. If you get a 20% hike and your basic becomes `36,000, your contribution will automatically increase to `4,320. This is a great way to build a corpus in the long-term.

The icing on the cake is that you can invest more than 12% of your basic salary. Millions of Indians welcomed the move when the budget hiked the annual investment limit in the PPF to `1.5 lakh. But Delhi-based PSU manager Naveen Parashar was not one of them. "I can't understand why salaried taxpayers are so excited about this development. They have always had the option to in vest in the Voluntary Provident Fund (VPF) and get the same tax benefits offered by the PPF," he says nonchalantly. Parashar puts an additional `14,700 into the VPF every month, taking his overall contribution to the EPF to `31,700 a month. This forced saving has helped him build a sizeable corpus in the past 15 years.

Central Provident Fund Commissioner K.K. Jalan echoes Parashar's views. "The VPF is an ideal saving instrument for high-income earners looking to build a tax-free corpus. Unlike the PPF, there is no limit to how much one can invest," he says (see interview).

EPS: The problem area

While EPF is a great way to save for retirement, it has its share of problems. One big wart is the Employee Pension Scheme (EPS).Launched in 1995, it is a black hole that gobbles more than it offers. The amount flowing into the EPS every month is very small, so most people don't even notice the deduction. It is 8.33% of the employer's contribu

The interest rate for this year is 8.75%. How does that compare with what other retirement options are offering?

The EPF offers a moderate return but is the best way to save for retirement, especially for high income earners. A lot of investors are excited that the annual investment limit in the PPF has been hiked to `1.5 lakh this year. But this option was always open to EPF subscribers by way of the Voluntary Provident Fund (VPF). They can invest more than the mandatory contribution in the EPF and enjoy the same tax benefits.

A survey shows that one out of every three subscribers to the EPF dips into the corpus prematurely. Why are subscribers not serious about saving through the EPF?

Till recently, subscribers didn't know where their money was and how much had they accumulated. But the launch of the online facility to check the EPF account balance has changed that. One can also get an e-passbook. If you can access your account and track it online, you will be incentivised to save more and not withdraw from it.

A lot of the withdrawals happen when people change jobs. Rather than wait endlessly for the transfer of the balance, they prefer to withdraw their money.

This problem too has been fixed by the launch of the online transfer facility. All a subscriber has to do is to register online and furnish his account details. Going forward, the allotment of Universal Account Numbers (UANs) to EPF subscribers will obviate the need for transferring the balance. UANs have been allotted to 4.17 crore contributors.

The deficit in the EPS could worsen in the future. Why isn't the pool system being replaced by individual accounts as in case of the EPF?

The intention of the EPS is to provide a minimum pension to the organized work force. It also offers pension to widows, children and. No other scheme offers such a benefit. tion to the EPF on behalf of the employee, with a cap of `6,500 a year. But the monthly contribution of `541 can grow into a huge amount over the long-term. Even at a modest interest rate of 8%, this tiny amount can burgeon into `12.41 lakh in 35 years.

However, this is not what happens to your contribution to the scheme. The amount just flows into a pension pool without earning any interest for you. The pension amount is calculated by taking into account the number of years you had contributed to the scheme and your basic pay at the time of retirement (see graphic).

Three years ago, an expert panel had suggested that the EPS be replaced with a provident fund-cum-annuity combo under which contributions would flow into individual accounts. The panel suggested that the balance in the pension account be used to buy an annuity on retirement. However, the CBT rejected the panel's recommendations.

Mercifully, the EPFO has now raised the eligibility ceiling for EPS to `15,000 a month.New joinees who are earning more than that will not be covered by the rip-off scheme.The entire contribution of their employer will flow into their EPF accounts.

The new look EPFO

The EPFO is fast shedding its dowdy image and using technology to turn into a more professional and nimble organisation. It has made several other investor-friendly changes in the past 12 months. Last year, it introduced the online facility for transferring the balance to a new account. This year, it has made it possible to check the account online.Going forward, all members will have a Universal Account Number which will be portable across employers and cities. UANs have already been allotted to 4.17 crore active contributors to the EPF. In the first four months of this financial year, the EPFO settled nearly 43 lakh claims. Of these, more than 68% were settled in less than 10 days.