Provident Fund is a government-managed retirement savings scheme for employees, who can contribute a part of their savings towards their fund, every month. In some PFs, the employer and employee make an equal contribution. These accumulated savings can be withdrawn as a lump sum at the time of retirement or the end of employment.

Types of Provident Funds

The various types of PFs are as follows:

  1. Employee Provident Fund (EPF) or Recognized Provident Fund - This is for employees earning up to ₹ 15,000 a month in firms with over 20 workers. An employee makes contributions to the PF from their salary. Employees get a UAN or Universal Account Number, which can be transferred when switching jobs to another company.
  2. General Provident Fund (GPF) - This is a government-maintained PF, for government employees to contribute to.
  3. Public Provident Fund (PPF) - A PF with a lock-in period of 15 years, with a minimum contribution of ₹ 500 and a maximum contribution of ₹ 1.5 lakh, yearly.

PFs are stable investment options, especially for those building a retirement corpus. They give good returns.

An added bonus of PFs was that before this financial year, contributions made towards PFs could be written off as tax-free. All income on provident fund savings was exempt from tax as well.

However, noticing that this rule was being misused, in her budget speech for 2021-22, Finance Minister Nirmala Sitharaman proposed thatPF contributions of over ₹ 2.5 lakh a year would be taxable. For PF accounts where employers make no contributions, this limit would be ₹ 5 lakh a year.

What Are the New Income Tax Rules?

On August 31, 2021, The Central Board of Direct Taxes (CBDT) introduced Income Tax rules as to how the PF contribution would be taxable.

The existing PF accounts will be split into two parts- taxable and non-taxable. Whatever amount you (the employee) contribute beyond ₹ 2.5 lakh per annum will be separately assessed for that financial year and the interest accrued on that portion will be taxable. These come under Section 9D, under the purview of the Income-Tax (25th Amendment) Rules, 2021.

Is it Something to Worry About?

Yes, in a year, if your contribution exceeds ₹ 2.5 lakh, you will lose the tax-free interest on your PF account balance. Employees with a basic salary up to approximately ₹ 1.75 lakh per month would not be taxed on the interest they earn on their PF account. Those earning more than ₹ 1.80 lakh as their basic salary per month would be affected. In addition, those who contribute extra to the VPF and the amount they contribute exceeds ₹ 2.5 lakh, their interest earnings would be taxed as well.

Two Ways the Contribution Can Exceed the Cut-off Limit

Your contribution may exceed the cut-off limit of Rs 2.5 lakh in two ways. The PF tax calculation is as follows:

1. PF Tax Calculation Based on Basic Salary

Generally, 12% of your salary is counted as your contribution to a PF. So, if your monthly basic salary is up to ₹ 1.75 lakh, your monthly contribution to the PF would be a maximum of ₹ 20,833 or ₹ 2.5 lakh in a year. Till this limit, the entire balance in your PF account remains tax-exempt. However, if your basic salary is more than ₹1.75 lakh per month, or you’re contributing more than ₹20,833 per month to your PF, the balance amount will be subject to income tax, which brings us to the second point.

2. PF Tax Calculation Based on Your Voluntary Contribution

Some employees contribute more than the mandatory 12% to PF. PF rules permit this, but the employer does not have to match that additional contribution. This allows them to earn a safe and tax-free return on their additional contributions. For example, an employee with a salary of ₹1 lakh can contribute ₹12,000 per month, which equates to around ₹1.44 lakh in a year. In addition, the employee contributes another 12% to the VPF, bringing the total contribution to ₹2.88 lakh for the year. In this situation, the interest earnings on ₹ 38,000 (₹2.88 lakh minus ₹2.50 lakh) will now be taxed.

Are There Any Other Tax-Saving Options?

Some employees make voluntary contributions of larger amounts to their PFs because of the lure of safe investing. However, there are other tax-saving investments you can make as well. Check out Future Generali India Life Insurance Company’s various tax-saving plans. Moreover, if you want to invest and grow your investment along with the market, check out our ULIP Plans. For any other assistance, we’re always here for you! Reach out to a financial advisor, click here.

New EPF Rules 2021 - The Latest Amendments

Besides the amendments above, the central government has decided to implement the important changes to the EPF act. Here are the new EPF rules that EPF members should be aware of:

  1. As per EPFO directives, seeding KYC’s (Aadhaar) is mandatory for all employees. Otherwise, the contribution of monthly benefits and subsequent interest will not take place.
  2. As per EPF guidelines, members (employees) who have an EPF account must update their nominee(s) in the EPF portal.
  3. As per a 2019 ruling from the Apex court, employees whose salary remains below the threshold limit of PF membership, i.e., INR 15,000/-, shall also include other allowances paid to the employee(s) as regular income in calculating PF and contributing accordingly.