Deeper PF cut will help in long term

This article was originally published in Postnoon on December 14, 2012. Co-author: Purvee Hetamsaria

There was urgency in Abhi’s voice when he called to ask me if he could see me. I immediately agreed. He was in my office before I could get myself a cup of coffee from the Cafe. What is it Abhi?, I asked. “You look disturbed”.

Abhi: Yes. I am disturbed. And who wouldn’t be? My salary just went down because of the Government’s action.

Nicky: Really? What did the Government do now?

Abhi: The Employees Provident Fund Organisation (EPFO) of India has come out with a notification which says that now we will have to contribute towards the provident fund on the basis of allowances as well. This will reduce my take home salary.

Nicky: Ah that! You should be happy. Don’t think short term. Think long term. You are forced to save more.

Abhi: What do you mean?

Nicky: See, earlier, you and your employer, both contributed 12% each, on your Basic plus Dearness Allowance (DA) only, towards the EPF. Now, suppose your Basic plus DA is ₹4,000. The contribution will amount to ₹480 from you and ₹480 from your employer. There is no contribution on the allowances that you receive. If your allowances total up to ₹2,000, your take home salary will be ₹4,000 minus ₹480 plus ₹2,000. That is ₹5,520. And your total contribution to EPFO is ₹960.

Abhi: Yes, this is exactly what happens in my case right now.

Nicky: But with the new circular, contribution will need to be made on Basic plus DA plus Allowances. This means, your contribution will be on ₹6,000. Hence, the total contribution to the EPFO by your employer (₹720) and you (₹720) will be ₹1440. This way, you take home only ₹5,280 but you save ₹480 more and your total income goes up by ₹240, the extra contribution made by the employer! So you should be happy.

Abhi: Hmmm…you are right, but I am still not happy about the lower take home salary. You know that I recently got married and have bought a flat too, which comes with a fat EMI.

Nicky (laughing): True Abhi. But saving for your old age is important too. And many employees structure their salary to increase allowances and decrease PF contributions. This means that they are not saving enough. Also, because of higher contributions to the PF account, you will be able to claim a higher amount as section 80c deductions in income tax.

Abhi: But the limit for section 80c is ₹1 lakh right?

Nicky: Yes. So it will be beneficial to you only if you are not able to meet the ₹1 lakh through your life insurance and existing PF contributions.

Abhi: So overall, you are saying, the government may not have done such a bad thing! Well, I am not happy, but I do understand the government’s point of view now. I’ll have to think of rationing certain expenditures though!

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