How does the EPF function?

Whenever you invest, you basically look to attain 3 financial goals – form wealth, have regular income via pension when you retire and thoroughly secure your family’s future. And while we purchase distinct financial items to mitigate each of the goals, there is one product that assists in achieving all three financial goals. The majority of us not just know regarding it but even invest in the same as it is a constituent of your salary. The product is called EPF or Employee Provident Fund, which can be accessed through your EPFO UAN.

Here in this article, we will present a simplified structure of the EPF member portal by breaking down every component. Also, we will look at here how it works, the rate of interest you can earn via it, and EPF withdrawal rules.

EPF: Basic construct

EPF is not just a scheme. This consists of 3 distinct schemes with 3 distinct objectives.

• The initial part of EPF is where you accumulate the retirement benefits. It is a wealth generation part of the scheme.
• The next part is the EPS or employee pension scheme. The purpose of EPS is to yield a pension after you reach the age of 58 years.
• The third and last part is the EDLI, or employee deposit linked insurance scheme, which is nothing but a life cover.

The prudent thing is you do not require registering separately for all such benefits. On registering for EPF, you automatically are registered for the EDLI and EPS also.

Let us view each of the components and its share in your income

EPF & your salary: the entire working

If you are a staff, you pay a specific portion of your salary towards the EPF scheme. The amount is mostly matched with equal contributions from the employer. The combined amount is deposited then with EPFO. And you continue to gather a specific interest rate each year on the amount deposited with the EPFO. For instance, let us consider you pay a sum of Rs 5,000 each month from your salary towards EPF. The combined amount, i.e., Rs 10,000, is deposited with the EPFO. You will avail 8.50 percent (present EPF scheme interest rate) each year on this deposited amount with EPFO. This rate of interest might change as the EPFO decides each financial year.

It is the basic workings of the EPF scheme. Now deduction towards EPF must be 12 percent of your basic salary according to the law. However, do remember, for purposes of EPF, income means just 2 things – your dearness allowance (DA) and basic. Here the salary does not involve your HRA, special allowance, conveyance allowance or any other advantage given in your income slip. Usually, companies in the private sector do not have any dearness allowance constituent, so it is just the basic salary that serves as a base for EPF calculation.

Contribution by an employee is matched by an employer. So that is another 12 percent. Thus, an overall 24 percent of your basic salary goes into the scheme. However, the whole 24 percent does not go to the first part of the EPF, i.e., the wealth generation part where your retirement-linked benefits are accumulated.

EPF, EPS (EPF pension scheme) and EDLI (EPF insurance)

EDLI or employee deposit linked insurance scheme in India is an insurance cover offered by EPFO. Registered nominee receives the lumpsum payment on the occasion of the demise of the person insured during the service period. Thus, you do not require paying the premium or contributing to the EDLI separately. You automatically can avail of this insurance once you get registered for the EPF scheme. Now, allow us to look at the split between EPS and EPF. The 12 percent that gets contributed by employee go into the EPF. But it is the employer’s 12 percent that gets split into various parts. 1/3^rd of the employer’s contribution to the scheme, i.e., 3.67 percent, goes into EPF. And a huge chunk, i.e., 8.33 percent, goes towards EPS. However, for the purpose of calculating EPS contribution, the rule requires that salary itself must be restricted at Rs 15,000.

Let us understand it using an example. Let us say the salary, i.e., the basic plus the DA (dearness allowance), is Rs 50,000 per month. Employee’s contribution is at 12 percent of Rs 50,000, i.e., Rs 6,000, and it would go to EPF. The employer’s contribution also will be Rs 6,000.

Employee’s contribution	12 percent	6,000
Employer’s contribution	12 percent	6,000

The whole employer’s contribution will not go to the EPF part. It will be divided into multiple portions, and here is how the split would look:

Employer’s contribution to EPF	3.67 percent of Rs 50,000	Rs 1,835
Employer’s remaining contribution to EPF	8.33 percent of Rs 35,000	Rs 2,915
Employer’s contribution to EPS	8.33 percent of Rs 15,000	Rs 2,915

The overall 24 percent of Rs 50,000 is a contribution towards this instrument. It comes to Rs 12,000. Of it, Rs 10,750 goes towards EPF. And Rs 1,250 goes towards EPS.

Employee’s contribution	12 percent of Rs 50,000	Rs 6,000
Employee’s contribution to the EPF	3.67 percent of Rs 50,000	Rs 1,835
Employer’s remaining contribution to EPF	8.33 percent of Rs 35,000	Rs 2,915
EPF contribution		Rs 10,750
Employer’s contribution to EPS	8.33 percent of Rs 15,000	Rs 1,250
Total	24 percent of Rs 50,000	Rs 12,000

In case you are salaried, having knowledge about the split can assist you in understanding the structure of your salary better. As an outcome, it can affect your take-home income. For instance, if your company permits it, you can choose a minimum mandatory provident fund contribution of Rs 1800, i.e., 12 percent of Rs 15,000. In this way, you can enhance your take-home income by having your human resource department rework other components of compensation.

Next, if you are an owner of the business, then you can play smart by formulating a salary structure where 100 percent of salary is basic pay. In this way, you can simply push more contribution towards employee provident fund, which can lower your tax outgo and form a prudent retirement nest in an avenue that endows tax-free returns. It is something many businessmen and HNIs do.