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Why EPF Will Fail You In Retirement

Business World Jul 17, 2015

Sunil Dhawan explains what are the steps you need to take to live comfortably after retirement Depending solely on EPF may not be the right decision by employees to meet post-retirement needs. Here are the steps to arrive at your exact retirement need and monthly savings required. Pause for a moment. And see how we all are building ways and means to fend for ourselves in the future. In our daily hustle and bustle, we tend to live mostly for the present. Retirement for most of us remains the most ignored goal. For others especially salaried employees, it could be lot of misplaced confidence when it comes to saving for retirement. Why Not To Bank On EPF: The interest rate on EPF varies each year and is currently 8.75 percent per annum for FY 2015-16. With inflation hovering around 9 per cent, the real impact on your money would be negative and will hardly help you create wealth. Debt assets are preservers of your principal amount of savings. The real-return i.e. inflation adjusted return is low in EPF and can tremendously damage your purchasing power by the time you retire. Is Contribution Enough: Look at the contribution both from employee and employer in rupee terms. Would that be sufficient to create a comfortable amount of corpus for retirement? Not all employers or corporates have a similar salary structure for their employees. If the basics salary is high, contribution too will be more compared to another employee in different organisation at similar level (same CTC) whose basic salary is lower. Employers may offer higher allowances while keeping the basic salary low.  The maximum that one gets to save in EPF is 12 per cent of the basic pay. The employer too contributes an equal amount, however, not all goes into employee’s EPF. Out of employer’s contribution, only 3.67 per cent comes into the EPF, balance moves into employee’s pension scheme. So, for employees with lower basic salary (not necessarily low CTC) may end up saving less towards their retirement. Banking solely on EPF by them could be more fatal. Salaried employees largely bank upon their employee provident fund (EPF) contributions. There are two concerns with EPF savings – contributions or savings might not be sufficient to meet retirement goal and secondly real rate of return after adjusting for inflation is low, EPF being a debt asset. The solution to both of these concerns may be met through investment products that are equity-oriented.   Get The Exact Retirement Number In Place: The first thing is to arrive at the exact post-retirement monthly needs. If you think, meeting it is possible through your EPF contributions is sufficient, it’s great. Else, you need to create your own portfolio and do some additional savings.   Here are the steps: 1.    Get a fix on your household’s present monthly expenses at current costs. 2.    Get the number of years left for you to retire. 3.    Inflate the household’s present monthly expenses at about 5 per cent. What you arrive at is the monthly expenses that you would incur once you have retired after adjusting for inflation. 4.    Now, estimate how much you corpus needs to be created to provide for the inflated monthly expenses amount. 5.    Finally, you will have to find out how much monthly savings (at around 8.5 percent) will be required to create that corpus. If monthly savings required is equal to your EPF, its fine. Else, you need to start additional saving. It’s highly improbable that EPF contributions will help you create enough corpus to meet post-retirement monthly inflation adjusted needs. Let’s work on an example. Assumptions: A’s age – 30 Years to retire – 30 (Y) Current annual expenses – Rs 2.5 lakh. (PC) Pre and post inflation rate. – 6 per cent. (Ri) Pre-retirement rate of return - 10.5 per cent Post retirement rate of return – 7 per cent. <img alt="" src="http://bw-image.s3.amazonaws.com/steps-lrg.jpg" style="width: 650px; height: 281px; margin: 1px;"> End note: In our above example, for some with Rs 20,000 expense, the income could be about Rs 40,000 a month. Results shows, he needs to save about Rs 6,500- Rs 9,000 a month to save towards retirement. That’s it! And it’s well within the reach. Life expectancy not considered. However, doing this small exercise on your excel sheet using the formulas will give you fair idea as to how much you need to save.