EPF vs SIP: Should you opt for 12% EPF contribution or go with minimum limit of Rs 1,800 and make SIP of rest of amount?

Employees' Provident Fund (EPF) is a retirement benefit scheme where you can contribute a total of 12 per cent of your basic salary, dearness allowance, and retaining allowance. The employer also contributes the same portion, of which 8.33 pec cent goes to the pension fund and 3.67 per cent goes to EPF. Twelve per cent is the maximum limit you can contribute under EPF; beyond that is known as a VPF contribution, where interest earned over 12 per cent contributions is taxed. A major benefit of the EPF scheme is that it comes under the exempt-exempt-exempt (EEE) category, where deposits, the interest earned, and the withdrawals are tax free.

The minimum amount from the employer's side for the EPF contribution is Rs 1,800.

If you are also opting for the same range, instead of going for a 12 per cent contribution and investing the rest of the money in mutual funds through the systematic investment plan (SIP), will it be a wise decision. 

Here, two factors are important to understand: the first is that you get a fixed interest rate of 8.25 per cent on EPF contributions.

But in a market-linked programme such as a mutual fund SIP, the investment can get returns beyond 50 per cent a year.

Some of the funds in the PSU thematic category (the best performing category in the last one year) have given returns of nearly 100 per cent. 

Won't you be losing money if you invest a full 12 per cent in EPF, specially when your salary is in a higher bracket and 12 per cent makes substantial money.

But the EPF contribution provides you with compound interest, where the amount grows faster when the investment grows older.

Along with that, your maturity amount, even if it is multiple crores, remains tax free.

Whereas mutual funds are market-linked programmes, and there is no guarantee that the funds will repeat their past performance in the future. 

If you invest in debt funds to be on the safer side than equity investments, you get returns below 10 per cent and that too in a lower interest rate scenario.

Though mutual fund investment also provides compounding, it requires long-term investment and patience from investors, who need to hold nerve when the performance of their mutual fund(s) is going through a poor phase.

Mutual fund investment also provides compounding, but you need to pay tax on short- and long-term capital gains, which are taxed at 15 per cent and 10 per cent, respectively. 

So, what should be the way out?  

Nehal Mota,Co-Founder, Finnovate, says that one should invest in market-linked programmes after exhausting the 12 per cent limit of EPF. 

"EPF is a unique investment with 8.25% government guaranteed returns. This is the one product where the employer also makes a matching contribution and yet interest is tax free. One can look at market linked products, after exhausting the 12% of (Basic + DA) limit for EPF."

To highlight the importance of EPF as a tax saving tool, she gives two examples, where she shows that with an equal contribution of Rs 1 lakh to EPF, the one who is in the 30 per cent income tax bracket will get more tax benefits than the one who is in the 20 per cent tax bracket.

Chart Courtesy: Finnovate 

In the above two examples, we see that each of the persons made an annual EPF contribution of Rs 1 lakh each, while the one in the 20 per cent salary bracket saved Rs 10,313 in tax, the one in a higher bracket saved Rs 11,786.