How to Calculate the Interest Rate on Provident Fund?

24-June-2021 |

We are aware of the importance of a savings plan in a financial portfolio. We set a certain amount of money aside for contingencies, for the higher education of children, marriage, etc. However, one of the most important aspects of planning is to secure ourselves financially during the twilight years of life through a retirement savings plan. A Provident Fund (PF) is a step in this endeavour to promise financial security when there is no income to supplement the household.

Being a traditional and conventional financial security tool, a Public Provident Fund is also an enticing proposition for setting aside a corpus for a comfortable post-retirement phase. A Public Provident Fund is a government-backed scheme that aims to inculcate the habit of saving amongst salaried individuals. However, because returns are an important factor in determining whether we are making the right investments, it is important to know how to calculate the rate of interest in these plans. A step before this, however, is to understand the definition of a Provident Fund. 

What is a Provident Fund?

To prevent financial vulnerabilities in the second innings of life, the Government of India outlined the Provident Fund as a retirement savings plan. The idea was to ensure that the golden years of retirement are spent living respectably without the stress of inadequate funds.

For salaried individuals, the corpus for their retirement is built by a certain percentage of contribution from the employee as well as the employer. The contributions made by both parties are equal. At the time of retirement, the employee is eligible to receive the maturity amount in a lump sum, which includes the contributions by self and the employer along with interest accrued on both. As the Provident Fund is a savings plan for retirement, the withdrawal is permitted only upon the completion of the maturity period.

Benefits of Provident Fund:

Aside from the financial freedom it offers post-retirement, there are several other benefits of a Provident Fund:

  • Tax Exemptions:

Under Section 80C of the Indian Income Tax Act, the contributions made towards a PF account are eligible for tax exemptions of up to ₹1.5 lakhs. In addition to this, even the interest accrued on the funds is free from taxes. If the account holder wishes to make a withdrawal after five years, then there is no tax liability. Contrarily, if the funds are withdrawn before five years, then the amount is subject to tax. The employer's contribution, as well as the interest accrued, are added to the final income and are taxed accordingly.

  • Lifelong Pension:

The percentage of the salary contributed towards a PF account both by the employee as well as the employer is 12%. However, out of the employer’s contribution, 8.33% is directed towards an Employee Pension Scheme (EPS). The retirement fund body claims that a lifelong pension is promised with 10 years of contribution towards EPF.

  • Loans Against Provident Fund:

Against the PF balance, one can take a loan if there is a financial emergency. The rate of interest for a PF loan is only 1%. However, the loan has to be repaid within 36 months of the disbursal of the loan. As per the guidelines by the Employees' Provident Fund Organisation (EPFO), 90% of the PF funds can be withdrawn for buying or constructing a new home. The PF account can also be used for home loan repayment. (Source: MoneyControl)

  • Insurance Benefit:

Insurance ensures the financial security of the policyholder’s loved ones in their absence. The EPFO also offers insurance coverage under Employee Deposit Linked Insurance Scheme (EDLI). In the event of the premature death of the policyholder, the nominees receive the death benefit. As per EPFO, the minimum assurance limit is ₹2.5 lakhs the maximum limit has been raised from ₹6 lakh to ₹7 lakh(These new limits are in effect for three years from 28 April 2021). The employer's contribution towards the scheme is 0.5% of the basic salary, whereas the employee need not contribute.(Source: PolicyBazaar)

Interest Rate on Provident Fund:

There are essentially two types of Provident Funds: Public Provident Fund and Employee Provident Fund. The PF interest rate for the financial year 2020-21 is 8.5% which applies to the accumulated fund and is entirely exempted from taxes(Source: Economictimes). The accrued interest is directly transferred to the account of the employee’s PF. The announced interest rate remains steady until the conclusion of the financial year. While a Provident Fund calculator can be used to calculate PF interest online, here are some details to bear in mind:

  • Although the PF accrues interest every month, it is transferred to the PF account yearly.

  • If no contributions have been made to the account for more than 36 months, then the account becomes dormant.

  • Even a dormant account accrues interest if an employee has not reached the age of retirement; however, a dormant account attracts taxes.

  • No interest is paid to the employee for the employer's contribution towards EPS, under which the pension is paid after the age of 58 years.

 

Calculating the Interest Rate on Provident Fund:

An employee’s PF account consists of two parts: the employee’s contribution and the employer's contribution. While each party contributes 12% (basic salary + dearness allowance) towards the PF account, out of the 12% of the employer's contribution, 3.67% is credited towards the EPF account, and the remaining 8.33% is directed towards EPS. To calculate the interest accrued on PF, consider the following example:

  • Basic Salary + Dearness Allowance = ₹30,000

  • Employee’s contribution is 12% of ₹ 30,000 which = ₹3,600

  • Employer’s contribution is 8.33% of ₹ 30,000 which = ₹2,499

  • Employer’s contribution towards EPF = Employee’s contribution – employer’s contribution towards Employee Pension Scheme = ₹1,101

  • Total EPF contribution per month = ₹3,600 + ₹1,101 = ₹4,701

  • PF interest rate for the financial year 2020-21 is 8.5% and so the PF interest rate applicable monthly = 8.5% / 12 = 0.7083%

For a hassle-free process, you can calculate PF interest online by using the Provident Fund calculator.

 

Conclusion:

It is important to plan for retirement early on in life. While schemes such as the Provident Fund can help build a corpus, investment in various life insurance policies can further help supplement the income in the post-retirement phase.

For instance, a guaranteed#income plan is another financial tool that is gaining popularity owing to its ability to undertake daily expenses when a steady income has stopped. It is a non-participating monthly income scheme for which an annual premium can be paid. There are several other policies in the market that you can choose from based on your requirements.

Therefore, investing in reliable insurance policies such as the Tata AIA life insurance is vital for the security of financial dependents. Thus, a PF coupled with an insurance policy would be an ideal combination to ensure future financial well-being.

 

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