Wednesday, February 6, 2013

Everything you wanted to know about your PF/Pension - How does it work? Does it beat inflation? How is interest calculated?

Introduction

There is a sizable chunk of our salaries that each month gets deducted under the head - well PF (Provident Fund). While it may be called just PF, the actual contributions go into two different accounts. The entire employee contributions goto PF whereas the employer's contributions get split between PF and Pension Fund. For most people, PF is the single biggest and probably the only kind of retirement planning they ever do. Whether this is enough or not will be discussed in another article, but basically it would depend on your individual circumstances.

PF/Pension - What goes where?

Every month there are three different contributions taking place in your PF account.
  1. 12% of the "Basic" (Basic +DA if you get DA as well) component of the salary is deducted as the employee's contribution to PF. So if your Basic salary is Rs. 10,000 p.m. then your PF contribution will be Rs. 1200.
  2. The employer is supposed to make an equal contribution. However, the Rs. 1200 that the employer contributes gets diverted to two different accounts. 8.33% of the "Basic" component of the salary is put in the Pension Fund (and not PF fund). However, this contribution to the pension fund is restricted only to Rs. 541 p.m.. Any excess is put in the PF fund.  So with our example 8.33% of 10,000 is Rs. 833. Only Rs. 541 out of this is put in the Pension Fund. The remaining 833-541 = Rs. 292 is put in the PF fund itself.
  3. The remaining part of the employer's equal contribution, i.e. 12% - 8.33 % = 3.67% of the "Basic" component is put in the PF fund alongwith any remainder from step 2 above. i.e. in our example, Rs. 367+ Rs. 292 (remainder from step 2) = Rs. 659 is the employer's contribution to PF.
To summarize our example,
  • Employee contribution is Rs. 1200 to Provident Fund.
  • Employer contribution is Rs. 659 to Provident Fund.
  • Employer contribution is Rs. 541 to Pension Fund.
So 24% of your Basic goes towards forced retirement planning by the government. As someone who should be interested in one's own financial planning and future, the next question one should ask is has this been a good investment decision (we will call it that even though no employee has a choice in the matter so it is not a decision really).

History of PF Interest rates and how it compares with inflation - last 15 years 

The table below gives you the interest rate paid by EPFO (the organisation that manages PF) for each financial year for the last 15 odd years. To see whether it has been a good investment or not, I have also added the inflation rate for that financial year. A good investment will beat inflation by atleast 2%. 

FromToPF Interest rateInflationDifference
1 Apr 199731 March 199812.00%8.52%3.48%
1 Apr 199831 March 199912.00%6.04%5.96%
1 Apr 199931 March 200012.00%10.83%1.17%
1 Apr 200031 March 200111.00%4.37%6.63%
1 Apr 200131 March 200211.25%4.93%6.32%
1 Apr 200231 March 20039.50%4.93%4.57%
1 Apr 200331 March 20049.50%3.58%5.92%
1 Apr 200431 March 20059.50%3.67%5.83%
1 Apr 200531 March 20068.50%3.54%4.96%
1 Apr 200631 March 20078.50%4.43%4.07%
1 Apr 200731 March 20088.50%6.17%2.33%
1 Apr 200831 March 20098.50%5.63%2.87%
1 Apr 200931 March 20108.50%8.59%-0.09%
1 Apr 201031 March 20119.50%12.50%-3.00%
1 Apr 201131 March 20128.25%10.41%-2.16%
1 Apr 201231 March 20138.80%


Source: This table has been created by me. 
1. The inflation rates have been arrived at by taking the Income Tax Department's published cost inflation index (CII) for each year. For example, if the CII for 1996-97 was 305 and 1997-98 was 331 then the inflation rate for 97-98 is (331-305)/305 = 8.52%.. This method has been used for each subsequent year.
2. Interest rates for PF each year have been taken from various reputed newspaper sources online.


As you can see, the interest paid by the EPFO doesn't beat inflation for three years (2009-2012) and is close to not beating inflation this year and in 1999-2000. That is a total of 5 years over 16. Overall though for many years it has beaten inflation comfortably. But for something that hundreds of thousands of people blindly put money in, one would have expected interest rates to be atleast on par with inflation for all years considering the EPFO doesn't invest in risky instruments such as the stock market at all.

How is your PF interest calculated?

The good news about PF interest is that it starts earning interest right from the day it is credited. So if you joined a company in the beginning of say May 2012, your May 2012 salary is paid out in the first week of Jun and your PF account should also be credited with your May PF deductions at the same time. 

On the 31st of Mar 2013 (when interest to be credited for that year is calculated), you will have kept your May PF contributions with the EPFO for 10 months and you will earn (10/12)*(interest rate for that financial year) as interest for that month. On the PF amount credited on the 1st of Jul 2012 (salary of Jun 2012), you will have kept your Jun PF contributions for 9 months and thus earn interest for that contribution (9/12)*(interest rate for that financial year)  and so on. 

Any amount kept for a year or more (PF contributions from previous years carried forward to the current financial year) will earn the full interest for that year. The good news is the interest is compounded annually. i.e any accumulated interest from the previous years will also earn interest on it. 

What can go wrong with your PF?

While all this may seem straightforward, several things can go wrong with your PF since it is money we are talking about here. Some unscrupulous employers in the past have delayed crediting PF at the right time to the EPFO's account  and there are others who haven't credited it at all. There are usually three parties involved in a PF transaction. The employer, a entity to which the employer outsources the PF work and the EPFO office. Anyone in between could drop the ball.

So just because you have a deduction in your Salary slip for PF doesn't mean it is getting credited. Unfortunately, the EPFO hasn't been very transparent in its operations in the past with its account holders. Some haven't received the yearly account slips (which is a slip of paper showing the previous years balance carried forward, this years contributions and closing balance for the year) for years together. Some haven't been given a complete statement of accounts for each year even when requested several times. Things however have improved a bit with several online tools available to check these for you.

Where to check your EPF balance and get your account statement?

If you just want to know your PF and Pension balance then you can goto http://epfoservices.in/epfo/member_balance/member_balance_office_select.php. You will receive a text message on your mobile number with the last calculated balance (usually updated in Mar of the previous financial year). But ideally, you should do one better and request a passbook that contains every transaction in your PF account. After all it is your money and you should know what is going on in your account. To do that goto http://members.epfoservices.in/index.php where you can register and request for your account statement. 

What to do if you have a complaint?

If things are not in order as you had expected then the first port of call would be your employer. If your employer claims to have done everything correctly, then you need to approach the EPFO office where your account is kept. You can register a complaint online at http://epfigms.gov.in/ OR better still visit the office in person to lodge a complaint.

How to claim your PF?

If you must claim your EPF (such as when you are no longer working for any employer, unemployed or self employed), the procedure to claim it is to fill in two forms. You need to submit Form 19 and 10C along with a cancelled bank cheque leaf (individual a/c). You can find these forms at http://epfindia.gov.in/downloads_forms.html.

If your account hasn't had any transactions for 3 years or more, then in addition you need to submit an Affidavit cum Indemnity bond, latest identity proof and latest address proof. The format for the bond keeps changing, please check with your employer for the right format to use and make sure you get it typed/printed on the right amount judicial paper. 

Conclusion

This article has sought to introduce you to PF and where your money is going. Ignorance in this important area of personal finance is rampant and hope this article clarifies some aspects of it. If you have any questions, just leave a comment and I will answer if I can. I am unable to help with your claims, statements etc. so please do not ask for such help. I can only clarify what is written in this article.