EPF and NPS: Balancing stability with market exposure

EFP vs NPS

EPF is a scheme run by the Employee’s Provident Fund Organisation (EPFO) to provide social security and retirement benefits to employees. Employers with 20 or more employees earning up to ₹15,000 monthly must contribute to EPF. However, employers can voluntarily contribute even if these conditions are not met.

Both the employer and employee contribute 12% of the basic salary plus dearness allowance to EPF, with the employer's contribution at 3.67% for the PF and 8.33% for the pension account. Additionally, employers contribute 0.50% to the Employee’s Deposit Linked Insurance Scheme (EDLI) and 0.50% towards administrative charges. For salaries above ₹15,000, the employer’s pension contribution is capped at 8.33% of ₹15,000, with the excess going into the PF account.

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NPS is a voluntary retirement savings scheme administered and regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Unlike with EPS, any Indian citizen, employee or self-employed, can join NPS individually or through an employer.

NPS allows for flexible investments in equity, government bonds and corporate debentures, and subscribers can also choose their pension fund managers (PFMs). It offers two types of accounts – Tier I (mandatory retirement) and Tier II (voluntary savings). Tier II provides greater flexibility on withdrawals. Tier I accounts have no upper limit for investments, but at least ₹1,000 must be invested annually. Subscribers can switch between investment options and fund managers, choosing between active and auto investment compositions.

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What are the returns like?

EPF has historically yielded an average annual return of 8% to 8.5%. NPS offers varying returns depending on what the subscriber invests in. Typically, equity investments yield between 15% and 17%, while government bonds and corporate debentures generate 7% to 9% returns. Alternative investment funds provide returns in the range of 6% to 8%.

In the table, we have compared the returns under EPS and NPS of an employee who is 40 years old, and earns a basic salary of ₹1 lakh. It is assumed that the contributions to EPF and NPS are equal, and that he will retire at the age of 60.

The contribution to the EPF will be 12% for each employee and employer. The contribution to the NPS will be 10% by the employer and 14% by the employee.

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As you can see, NPS has the potential to get you a higher pension. However, NPS suits those with higher risk appetites, who don't mind accepting market fluctuations in return for higher growth.

Choosing between EPF and NPS thus depends on factors such as your risk profile, desired retirement corpus, and tax planning preferences. EPF offers stability and guaranteed returns, and is suitable for employees with low risk appetites. NPS is for investors who want market exposure. Given that markets can often be volatile, it's best to have a balanced retirement strategy by investing in both EPF and NPS.

Naveen Wadhwa is vice president, Taxmann. Sagar Phukela, an associate at Taxmann, contributed to the article.