Mutual Funds vs. Employees Provident Fund

Cambridge Wealth
Dec 30, 2024
7 min read

Whenever most of us invest, we primarily want to achieve three financial goals: creating wealth, having a regular income through pension when we retire, and securing our family's future. While we might consider different financial products to meet each of these goals, there exists one product that works towards all three. The majority of us are not only familiar with it but also contribute to it because it's a part of our salary – the Employees' Provident Fund (EPF). This article dives into the world of Mutual Funds vs. Employees Provident Fund, simplifying its structure and breaking down its components. We'll explore how EPF works, the interest rate you can earn, and the rules governing EPF withdrawals. We'll then compare EPF with another popular investment option – Mutual Funds – to help you make informed decisions for your financial future.

What is an Employees' Provident Fund?

The EPF is a retirement savings scheme mandated by the Government of India for most salaried individuals. It works through contributions from both you and your employer, which is typically 12% of your basic salary, and dearness allowance. Additionally, your employer matches this contribution, thereby making the total contribution 24% of your salary. However, the entire 24% does not contribute towards the EPF, as there are multiple parts in the EPF scheme such as The Employees' Pension Scheme (EPS), the Employee Deposit Linked Insurance Scheme (EDLIS), and the Employees' Provident Fund (EPF) itself. The amount contributed gets deposited into your EPF account, and the government declares the interest rate annually. It is a mandatory contribution for salaried employees, wherein contributions accumulate over time and serve as a corpus for retirement.

How does an EPF work?

While often referred to as a single scheme, EPF actually functions as three distinct programs:

Accumulating Retirement Savings: A portion of your EPF contribution goes towards building your retirement corpus, essentially the wealth creation aspect.
Securing a Monthly Pension: The Employees' Pension Scheme (EPS) utilizes part of the employer's contribution to provide you with a monthly pension upon reaching the age of 58.
Life Insurance Protection: The Employee Deposit Linked Insurance Scheme (EDLI) acts as a built-in life insurance policy. When you enroll in EPF, you're automatically covered by EDLI at no additional cost. In the unfortunate event of your passing while employed, a lump sum amount is paid to your designated beneficiary.

The convenience lies in automatic enrollment. By subscribing to EPF, you're automatically registered for EPS and EDLI, simplifying the process.

The maximum contribution allowable under EPF is 12%; any additional contribution falls under the Voluntary Provident Fund (VPF), subjecting the interest earned on amounts beyond 12% to taxation. One significant advantage of the EPF scheme lies in its categorization under exempt-exempt-exempt (EEE), wherein deposits, interest accruals, and withdrawals remain tax-free up to a certain extent, and subject to certain conditions. However, it is tax exempt only if there are active contributions to the EPF account.

Any interest accrued in the EPF account after the termination of employment is subject to taxation, regardless of whether the member has completed five years of consecutive service with contributions to the PF.

Structure of an EPF Split

Each month, both the employer and the employee allocate 12% of the employee's basic salary and dearness allowance to the EPF scheme.
The employer's contribution is allocated as follows:
- 8.33% towards the Employees' Pension Scheme (EPS), ensuring a monthly pension after retirement.
- 3.67% towards the employee's EPF account.

Let's look at this with a practical example. Suppose your salary, basic and DA, is Rs. 60,000. The employee's contribution is 12% of 60,000 (Rs. 7,200) and the entirety of it will go towards the EPF. The employer's contribution is also 12% of 60,000 (Rs. 7,200), but it will be split into EPF and EPS.

To determine the contribution to the Employees' Pension Scheme (EPS), regulations mandate capping the salary at Rs. 15,000. Consequently, once the EPS contribution is computed, the remainder of the employer's 12% contribution from the total salary is combined with the initial 3.67% allocated to the EPF.

The subsequent table provides a visual representation of this process using an example:

(Table: Employer's EPF and EPS split)

Particular	Calculation	Amount in ₹
Initial Employer’s contribution to EPF (3.67% of Salary)	3.67% of ₹60,000	2,202
Employer’s contribution to EPS (8.33% of Salary capped at ₹15,000)	8.33% of ₹15,000	1,250
Employer’s remaining contribution to EPF (Remainder of the ₹7,200 (12%), after subtracting the initial EPF and EPS contributed, to be added to EPF)	₹7,200 - (₹1250 + ₹2202)	3,748
Total Employer's Contribution		7,200

Therefore, a total of ₹5,950 will be contributed to the EPF and an total of ₹3,748 will be contributed to the EPS. Amounting to ₹7,200 contributed from the employer.

EPF Withdrawal Rules

There exist three circumstances under which it's permissible to withdraw 100% of the EPF:

Upon reaching the age of 58.
In the event of unemployment lasting two months or more.
In case of the untimely demise of the member, whereby the entire corpus is transferred to the nominated beneficiary.

Should you wish to make an early withdrawal from your EPF account, it's imperative to consider various terms and conditions. Among these, the initial condition revolves around the specific scenarios that warrant premature withdrawal. These encompass distinct circumstances such as education expenses, land acquisition, marriage, medical emergencies, home loan repayments, and more.

To better understand the intricacies involved, let's delve into a few scenarios:

For medical purposes, you're entitled to withdraw either the accumulated corpus of the employee or six times the monthly salary, whichever amount is lower.
Should you require funds for a wedding, a prerequisite is a minimum of seven years of service. Upon meeting this criterion, you can withdraw 50% of the employee's contribution along with accrued interest.

The crux of the matter concerning withdrawals is the variance in rules based on the intended purpose. Hence, it's essential to remain cognizant of these distinctions.

It's crucial to highlight that EPF withdrawals made prior to completing five years of uninterrupted service are liable to taxation.

What is a Mutual Fund?

A Mutual Fund pools money from multiple investors and invests it in a basket of assets like stocks, bonds, and other securities. A professional fund manager oversees these investments, aiming to generate returns for investors.

There are various types of Mutual Funds catering to different risk profiles. Equity Funds invest primarily in stocks and offer the potential for high returns, but also carry higher risk due to market fluctuations. Debt Funds invest in fixed-income securities like bonds and offer lower risk with predictable, though often lower, returns. Hybrid Funds offer a mix of equity and debt, balancing risk and potential returns.

Additionally, mutual funds provide the option of Systematic Investment Plans (SIPs), which allow investors to invest a fixed amount at regular intervals, such as monthly or quarterly. SIPs help inculcate the discipline of regular investing and benefit from rupee cost averaging, wherein an investor can potentially lower the average cost of their investment by accumulating more units when the prices are low and fewer units when the prices are high.

Key Features of Mutual Funds

Diversification: Mutual Funds spread your investment across various assets, mitigating risk from any single asset underperforming.

Professional Management: Fund managers with expertise handle investment decisions, freeing you from actively monitoring the market.

Variety of Options: Choose a Mutual Fund that aligns with your risk appetite and investment goals.

Potential for High Returns: Equity Funds, particularly over the long term, have historically offered higher returns compared to fixed-income options.

Liquidity: Depending on the type of Mutual Fund, you may be able to redeem your investment quickly (open-ended funds) or face a lock-in period (closed-ended funds).

Systematic Investment Plans (SIPs): Mutual funds offer the flexibility of SIPs, which enable investors to invest small amounts periodically, making it easier to start investing with limited capital.

Who Should Invest in Mutual Funds?

Mutual funds are well-suited for investors with a moderately high-risk appetite and a longer investment horizon. If you're seeking the potential for capital appreciation and are willing to navigate market fluctuations, mutual funds could be an ideal choice. Additionally, investors looking to diversify their portfolio and benefit from professional management may find mutual funds appealing.