What is Provident Fund (PF) in the Indian salary structure?
- What is provident fund?
Provident Fund (PF) is a government-initiated and managed retirement scheme for employees. It can be thought of like a piggy bank in which a child deposits some money every month. The deposits into a provident fund are deducted every month, directly from the employee’s salary. The employer contributes equally to the employee’s provident fund. For instance, if 12% is deducted from the employee’s salary (to be deposited into the PF), the employer pays 12% as well into the employee’s PF.
Employee Provident Funds (EPFs) are of 3 broad categories:
1. Statutory Provident Funds (under thew Provident Fund Act, 1925): maintained by the government and semi-governmental organizations, local authorities, universities, recognized educational institutes, railways, airways etc. Everything under SPFs is exempt from tax, even if the contributions are over 12% (more on taxability later).
2. Recognized Provident Fund (Employee’s Provident Fund and Miscellaneous Provisions Act 1952): managed by the PF commissioner primarily. However, if an organization decides to handle PF on its own, a trust approved by the IT Commissioner has to be created. This trust will handle provident funds by following all the official rules of PF.
3. Unrecognized Provident Fund: this PF is not approved by the IT Commissioner. Typically, companies with less than 20 employees become an overhead for PF Commissioners who then refuse to identify the PF as a valid one. Employees’ contributions to such a PF are not exempted from tax (no matter the contribution)! Such UPFs are a result of lawmakers not wanting to take formal efforts and routes for small companies, just because the fruits involved are smaller.
- PF Withdrawals
Money invested in the provident fund is basically frozen under a lock-in period. An employee can only withdraw certain percentages of the money from the provident fund before retirement. At 58 years of age (retirement), the money can be withdrawn in full. At 57, an employee can withdraw 90% of the amount. Of course, partial pay-outs of the provident fund amount is permissible for special needs like education, weddings, house constructions, or medical emergencies.
|Reason||Withdrawal Percentage of PF Permissible||Prerequisites|
|Medical treatment (of oneself or one’s immediate family)||6 months basic wages or employee’s share with interests (whichever’s lower)||No minimum service period|
|Marriage (of oneself, siblings, or child)||50% of the employee’s share||Minimum 7 years in service|
|Education (of oneself, or children studying in classes above 10th)||50% of the employee’s share||Minimum 7 years in service|
|Repayment of home loan||Maximum 90% of both employee’s and employer’s shares||Minimum 10 years of service. Property needs to be registered under the employee’s or spouse’s or joint name.|
|Renovations||12 times the employee’s salary||Minimum 5 years in service|
|Purchase of house / land / plot||24 times of the employee’s salary||Minimum 5 years in service|
After PF maturity, or retirement, or even employee termination, the provident fund amount is handed out as a lumpsum.
2. Taxations on provident fund?
The purpose of a provident fund is to provide a safety net to employees after the retire / face sudden termination. Therefore, a PF functions as an investment tool. So, what about the returns of a PF? Are they taxable? Depends on the tax regime you have opted for. The new tax regime has lower tax rates, but requires the taxpayer to forego all previous tax exemptions. Under both the old and new tax regimes, the employee is exempted from tax as long as the employer’s contribution is less than or equal to 12%. If the PF contribution exceeds 12%, the returns are taxable in the hands of the employee.
But what is different about the two tax regimes w.r.t PF? The difference is in the tax exemptions. If you opted for the new tax regime for FY 2020-21, you could not claim any tax break on employee provident fund or any of the other 70 tax exemptions. If you chose to opt for the existing tax regimes, you could claim tax exemption on your PF (along with other tax breaks).
- Other Considerations for Employee Provident Fund
- Interest Rate for PF contributions is 8.5% per annum.
- Wage ceiling for provident fund applicability is RS 15,000.
- EPF is mandatory for organizations with over 20 employees (but companies with fewer employees can also opt for it)
- Optimizing Salary Structure for Maximum PF benefits
An employee’s salary is divided into fixed (base salary) and variable parts (incentives, bonuses, travel employees, and PF contributions). However, if not handled properly, employees become disgruntled by the in-hand salary and the benefits that they get. Provident fund calculations can become a labyrinth if not treated with care. Especially for foreign companies struggling to find footing in Indian markets. If you are looking to stabilize the salary structures at your company and need assistance, Remunance can help. We help businesses optimize their returns from India operations. One of our services is the institution of proper salary structures for your employees in India, to avail maximum benefits of provident funds and in-hand salaries.