The government notified the Employees’ Provident Fund (EPF) interest rate at 8.1% for FY 2021-22. Though the EPF interest rate for FY2022 is lower by 40 bps compared with the previous year, however, it is still higher than the interest rate/returns offered by other debt investment products. Further, with the Reserve Bank of India (RBI) hiking the key policy rates (repo rate), it is likely that interest rate on EPF will be hiked in the coming years.
Keep this in mind many would want to hike their EPF contributions by taking the VPF route. Did you know that by doing this not only do you earn a higher return on your savings, but it also ensures that the interest earned via EPF and VPF contributions remains tax-free?
This is because effective from April 1, 2021 (FY 2021-22), interest earned from the EPF account will be taxable if the employee’s own contribution exceeds the specified amount. This specified limit also includes the contributions made by the employee via Voluntary Provident Fund (VPF) to the EPF account.
Thus, if an employee’s own contribution via EPF and VPF exceeds Rs 2.5 lakh in a financial year, then the interest earned on the excess amount will be taxable in the hands of an individual. An additional EPF account will be opened for the crediting of interest earned on the excess contribution.
So, how much you should invest via VPF to ensure that the interest earned from both EPF and VPF contributions does not become taxable? Effectively, the total EPF account contributions via EPF and VPF should not exceed Rs 2.5 lakh in a financial year. The answer to the question, however, depends on the mandatory EPF contribution you make every month.
There are two ways to know your mandatory EPF contributions:
a) Check the mandatory EPF contribution from your salary slip.
b) Calculate the 12% of your basic salary to know mandatory EPF contribution.
Once you know your mandatory annual EPF contribution, then the same must be subtracted from Rs 2.5 lakh. This will let you know how much you can invest via VPF.
Here is an example of how you can calculate your annual VPF contributions.
Let’s say you are earning Rs 30,000 per month as basic salary. The mandatory EPF contribution comes to Rs 3600 per month (12% of Rs 30,000). The annual EPF contribution is Rs 43,200 (Rs 3600 X 12). The maximum amount that you can invest via VPF will be Rs 2,06,800 (Rs 2.5 lakh less of Rs 43,200) in a financial year. This is the maximum amount you can invest while ensuring that interest earned from it remains tax-exempt in your hands.
If you are a government employee
For government employees or those employees whose employer does not contribute to the EPF account, the limit is Rs 5 lakh instead of Rs 2.5 lakh. Using the example above the maximum amount one can invest via VPF will be Rs 4,56,800 (Rs 5 lakh less of Rs 43,200).
Not just a one-time exercise
Once the VPF contribution is known then you should not assume same amount will continue in the future years as well. This is because every time you get a salary hike, your mandatory EPF contribution also hikes. Thus, you must ensure that you can contribute via VPF without crossing the tax-exempt threshold in future years as well.
Continuing from the example above, suppose post the appraisal season, the basic salary is hiked to Rs 35,000. The annual mandatory contribution comes to Rs 50,400. Hence, the maximum amount that one can contribute via VPF will reduce to Rs 1,99,600 (Rs 2.5 lakh less of Rs 50,400).