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Proposed PF Rule: Important Things to Know
Current Rules: The current PF rules state that 12% of the basic salary that a person earns will be deducted from his income as Employee provident fund. Remember that the company contributes an equal amount on behalf of the employee. Before we proceed to understand the new proposed rule it is imperative that one understands what constitutes the basic salary.
As per the EPF rules, 'basic wages' includes all emoluments paid to the employee, which excludes house rent allowance, dearness allowance, cash value of any food concession, overtime allowance, bonus and commission. Barring a few allowances like special allowance and transport allowance would make up the EPF calculation.
Newly Proposed Rules:
A year ago the Madras High Court and the Madhya Pradesh high court held that the various allowances paid to employees should also be considered while computing the PF contribution. This prompted the EPFO to issue a circular to the effect. This means that for calculation of PF contribution many more of the allowances will be included.
One obvious impact of this would be that the take-home pay would be dented. But what it also means is that retirement savings will become higher. We need to view the latter point in the perspective of increasing life expectancy. The impact of the new rule is discussed below:
Impact of the new rules on the salaried persons:
Impact on retirement savings:
I would like to start off with the positive impacts beginning with higher retirement savings. Recent demographic data reveals a well-known fact regarding the life expectancy. The life expectancy of Indians, according to the World Health Organization's health statistics 2011, was 65 years in 2009. Compare this to the average LE of Indians in the year 1990 which was 57 years. But the disturbing truth that accompanies this good health news is that we do not have enough financial support to see us through these 8 added years in our LE. With increase in PF deductions and given the fact that the employers contribute an equal amount, the increase will act as a boon for the salaried segment during their twilight years. On an average an employee would be increasing his retirement savings by atleast 50%. This would enable him to lead a fairly comfortable life post retirement when the comfort and security of a regular salary is no longer available.
Impact on current commitments:
This could be a bad news for those who have already entered into financial commitments like housing loan, pension policies, etc. The worst hit, if this rule gets implemented would be individuals whose expenses are high already and those who have entered into long term investments. For those used to living a comfortable life style, this would mean taking a huge hit on the life style. For those who have other financial commitments, a reworking of the fund allocation towards the other saving schemes becomes mandatory.
Impact on the take home pay:
The take home pay will become lesser as discussed earlier. The dip in the pay could be anywhere in the range of 6% to 8%. One more aspect worth a thought is the position the employers would take towards their increased contribution. They may try to rework the salary structure in such a way that they do not take any sizeable hit due to the new rule.
If this happens then the take home pay may dip further deepening the employees’ woes. A change in the approach towards the financial planning, therefore, becomes the need of the hour.
Impact on the current saving schemes:
The fate of many savings schemes like the SIP, ULIP, child plans, pension policies, etc. would become uncertain. Even those who are in a mood to save money would take a ‘wait and watch’ approach till clarity emerges on the new rule. Even inflow of funds in PPF, PO savings scheme, etc. will see a dip as it would become redundant to have all ‘eggs in one basket’.
Nevertheless, it is too early to predict the change and its long term effects. Firstly, there are no clear rules on what will now constitute the basic salary. The accounting house PricewaterhouseCoopers notes, "There are conflicting judgements by high courts on the interpretation of the term 'basic wages' provided in the EPF Act
"The decision of the Supreme Court will provide a direction in the matter. Till then, this circular is a wake-up call for employers to review their position in relation to their compensation structure," noted PricewaterhouseCoopers.
Contributed By: Aparna K S
Aparna has worked for Stock Holding Corporation of India Ltd (SHCIL). She has hands-on experience in various financial products. She also has expertise in various mutual funds, pension policies & other financial products. She is currently a freelance writer on various domains including finance
- hrajan:Nice explanation of the subject.Keep it up16-Feb-2013 09:00 AMReply