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Provident Fund (PF) interest rate raised to 9.5% – Implications for you

The interest rate on PF has been raised by 1% to 9.5%. Read on for more details, and to know what you should be doing now.

For FY 2010-2011, the rate of interest on Provident Fund (PF) has been raised by 1% – from 8.5% to 9.5%. This decision was recently taken by the Employees Provident Fund Organization (EPFO).

(To know more about terms like FY and AY, please read “Income Tax (IT) Jargon – Financial Year (FY), Assessment Year (AY) and Previous Year (PY)”)

This rate of interest would apply to employees in public sector and private sector. This revised rate of interest would be paid out by both EPFO and exempted trusts managing PF money.

Please read “Provident Fund (PF) and Voluntary Provident Fund (VPF)” to get in-depth knowledge about provident fund (PF) and voluntary provident fund (VPF).


Some Background

The interest rate on EPF is set by the EPFO every year. Till last year, the rate was 8.5%, which has now been revised to 9.5%.


What does this rate hike mean?

As you would know, this 9.5% rate of interest – which is completely risk-free – is higher than prevailing market rates.

Add to this the income tax benefit available under section 80C for PF / VPF payments, and the effective returns are as high as 13.8%.

Bank FDs today pay in the range of 7.50-7.75% for longer maturities of 10 years. Even Public Provident Fund (PPF), which is similar in terms of safety and income tax benefits, pays only 8% interest.

So suddenly, PF has become the most attractive investment option for risk-averse investors!


What should you do?

PF is meant for long term savings, primarily retirement. It creates a strong, solid core around which you can build your retirement portfolio.

As you would know, the best investment option for the long term is stocks, and therefore, most of your long term investment should be in equities. This is especially true if you are young.

(Please read “Stocks – The winning bet for the long term” and “Equity Investment is Risk Free – Here’s the Proof” for more).

Thus, most of your long term investment, especially for retirement, should be in equities or equity mutual funds (MFs).

(To know whether you should invest directly in shares or through a MF, please read “Direct investment in Stocks versus Mutual Funds (MFs)”).

However, if you feel you need to invest more in risk-free avenues, or if you think the proportion of risk-free investments (PF, VPF, PPF, RBI bonds, etc) in your retirement fund portfolio is less, you can start contributing more towards Voluntary Provident Fund (VPF).

This is because with this increase in rate for PF, it has become the most attractive investment option among all long-term, risk-free avenues.

Please read “Provident Fund (PF) and Voluntary Provident Fund (VPF)” to get in-depth knowledge about provident fund (PF) and voluntary provident fund (VPF).

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