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Sunday, February 23, 2014

Voluntary Provident Fund (VPF)

For risk-averse investors who want to invest for their retirement, Public Provident Fund (PPF) seems to be a good choice. But considering there is a limit on the maximum amount that you can deposit in your PPF account every year, and that inflation will certainly undo part of your wealth creation effort, you need other options to augment your savings.
What are the other options to earn secure Tax free returns?
While gifting money and investing in your non working spouse's name or your adult child's name are some legal options that can help you save taxes and earn secure tax free returns, but there is another super option that is mostly ignored and is definitely worth considering. It is the investment in the age old voluntary provident fund (VPF)

Why VPF?
Voluntary Provident Fund (VPF) is one way to bump up your retirement savings. Besides, it brings you host of tax benefits as well, and augments well with the principle of investing before income tax deduction.

What is VPF? 
Every month, your employer deducts 12 percent of your basic salary (including dearness allowance) towards Employees’ Provident Fund (EPF). Actually, you can contribute a lot more, over and  above the compulsory deduction of 12 percent. In fact, you can contribute the entire basic salary (i.e., remaining 88 percent) towards VPF even if your employer is paying only 12 percent.

The biggest advantage of VPF investments.
The biggest advantage of a VPF account is that investments in it are made from your "pre-tax income". This is one of the wealth management principles as mentioned in the book "From the Rat Race to Financial Freedom". If you are in 30% income tax bracket, this principle can be understood by the below example. 

An illustrative example
If you wait for your salary of lest say Rs. 70,000/- and invest Rs. 20,000/- from your net salary in PPF, you get approx 9% of 20,000/- in one year, which yields a balance of Rs. 21,800/-. 
If, instead of that, you invest Rs. 20,000/- prior to your tax deduction in EPF, then the equivalent invested amount in EPF would be Rs. 30,000/- (pre-tax salary portion considering you were in 30% tax bracket) and assuming a similar rate of interest of 9%, your balance after 1 year would be Rs. 32,700/-. 
Understand and realise that there is a whopping 50% difference in your balance after year 1.

Increasing VPF contribution
If you want to increase your VPF contribution, you can do so at any point during your employment. However, many employers tend to provide this option only at the start of the financial year. In some cases, you can do it online on the company's HR website throughout the year.

Income Tax Benefits
  • Employees’ contribution is eligible for deduction under Section 80C of the Income Tax Act, subject to a maximum of Rs1 lakh.
  • Interest income is not taxable unless the interest rate exceeds the statutory rate, which is 9.5 percent at present.
  • Redemption is tax-exempt, but taxable if withdrawn within the first five years of service (as with EPF)

Who should invest in VPF? 
For risk-averse investors who are close to their retirement, VPF is a very good option. I say close to retirement, only because your blocking period would be less. If you are ready to get the money blocked, this is a very good investment at all times for all ages.

This may just be the right investment that you were looking for. Ignore it at your own peril.

For more details on VPF and hundreds of other investment options that can lead you to financial freedom, read the bestselling book "From the Rat Race to Financial Freedom"


Cheers

Manoj Arora
Freedom can buy you what money cannot !!

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