Transfer EPF, don't withdraw it

The money you initially put into EPF, the interest you earn and, finally the money you withdraw after a specified period, is all exempt from income tax.

When you change jobs, don't withdraw the money from your Employees' Provident Fund (EPF).

Instead, transfer it to the account with your new employer. Here are five reasons why you should do so.

Legal block

You can apply for withdrawing EPF only if you are not employed for two months after leaving the previous job.

So, if you take up a new job in this period, the law requires you to transfer the EPF balance. This is because the EPF is meant to contribute to your retirement corpus.

Corpus for later years

EPF contribution is one of the best and least risky ways for salaried people to build their retirement nest.

You compulsorily save a minimum 12 per cent of the Basic and Dearness Allowance (DA) of your salary every year for the long-term. In most cases, the employer makes an equal contribution, a part (upto Rs 541 per month) of which is allocated to the Employee Pension Scheme and the rest towards EPF.

Both the employer's and your contribution to the EPF earns interest at rates declared each year.

When you retire, you get the balance in the EPF account along with the accumulated interest. Say you start working at the age of 25, earn Rs 15,000 a month as Basic and DA, and contribute 12 per cent to the EPF.

Also, your employer contributes an equal amount, a portion of which goes to the EPF.

If your Basic and DA grow by 5 per cent each year, EPF contributions continue, and the balance in the account earns interest at 8.25 per cent annually (rate for 2011-12), you will have a corpus of around Rs 1.4 crore at the age of 60.

Besides, the employer's contribution towards the pension scheme, accumulated over the years, will enable you to draw monthly pensions later in life.

Tax benefits

Contributing and continuing with EPF offers several tax advantages. The money you initially put into EPF, the interest you earn and, finally the money you withdraw after a specified period, are all exempt from income tax.

This contributes to healthy effective returns on your investments.

Your contribution each year up to Rs 1,00,000 is eligible for tax deduction. If you are in the 20 per cent tax slab and the contribution earns 8.25 per cent annually, the effective return you earn is 10.31 per cent (8.25*100/80). The higher your tax slab, the more the effective return.

Tax hit on withdrawal

If you withdraw your EPF balance before completing five years of service, whether with the same employer or with different employers, you stand to pay much on taxes.

In such cases, you will have to pay tax on the employer's contributions to the EPF during the earlier years. Tax benefits claimed earlier on your own contributions will also be lost.

Besides, you will have to pay tax on the interest earned on both your and the employer's contribution to the EPF. All this can erode your returns.

EPF vs. PPF

EPF interest rate for 2011-12 was sharply reduced to 8.25 per cent from 9.5 per cent in 2010-11.

This was also lower than the 8.6 per cent available on public provident fund (PPF), which is similar to EPF in terms of risk-profile and tax benefits.

Yet, even in this scenario, it may not make sense to withdraw from EPF and transfer to PPF. In the past, there have been many years when EPF rate has been more than that on PPF.

This could happen again because interest rates on PPF have now been linked to market rates and could head lower in the years ahead. Ideally, there should be room for both EPF and PPF in your retirement portfolio.