Provident Fund Money: Where Is It Invested?

A provident fund is a government-backed retirement fund used in several countries, including Singapore, India, and South Africa. It is a savings scheme that is contributed to by both the employee and the employer, with the aim of providing financial support to the employee upon their retirement. The fund is managed and controlled by the government, which also decides how the money is invested. While the specifics of provident funds differ from region to region, they generally operate like a mix of Social Security and 401(k)s in the United States. In India, the Employees' Provident Fund Organisation (EPFO) manages funds worth over Rs 11 trillion and has millions of subscribers. The EPFO invests in central government securities, state development loans, bonds of private sector companies, and ETFs.

Provident fund investment regulations

Provident funds are government-backed retirement savings plans, prominent in Asia and Africa. They are designed to provide financial support to employees when they retire. Both the employee and the employer contribute to the fund, with governments setting minimum and maximum contribution levels.

In Pakistan, the Provident Fund is established in the following three forms, each with its own regulations:

• Statutory Provident Funds: These are set up under the Provident Fund Act of 1925 and are maintained by the government, semi-government organisations, local authorities, and other institutions. Payments from these funds do not need recognition from the Commissioner of Inland Revenue and are exempt from income tax.
• Recognised Provident Funds: These are recognised by the Commissioner of Inland Revenue under the Sixth Schedule of the Income Tax Ordinance of 2001. Maintained by private sector organisations, payments from these funds are also exempt from income tax.
• Unrecognised Provident Funds: These funds have no exemptions from tax. The employer's contributions and interest are taxed only once, at the time of payment to the employee.

In Thailand, the Provident Fund Act allows employees to contribute between 2% and 15% of their monthly salary to the fund. The employer determines the contribution rate within this range. The employer's contribution is usually no less than the employee's, and may increase depending on how long the employee stays with the company.

Provident funds in Pakistan are managed by financial institutions and the funds are invested in various financial instruments to generate returns. In Thailand, the investment of provident funds is regulated by the Securities and Exchange Commission (SEC).

Investment plans

Principal Asset Management, for instance, has proposed the "Principal Target Date Fund", which is designed to provide an appropriate investment plan for employees by automatically adjusting the member's portfolio each year. The portfolio is closely managed by a fund manager who adjusts the asset allocation and risk to suit the member's age, decreasing the portion of risky asset investments (e.g. stocks) and switching to investing more in fixed income as the member gets older.

In India, the Employees' Provident Fund Organisation (EPFO) manages funds worth over Rs 11 trillion and has millions of subscribers. The EPFO does not have direct exposure to equities but invests in exchange-traded funds (ETFs). It invests in Central Government securities, state development loans, bonds of private sector companies, and ETFs. The EPFO can invest up to 5% of its annual incremental deposits in commercial paper from corporates and between 5% to 15% in equities and related investments.

In Thailand, the "Provident Fund Act" allows employees to contribute between 2% to 15% of their monthly salary to the fund. The employer's contribution is usually no less than the amount of the employee's contributions, and they may decide to increase the contribution rate gradually according to how long the employee stays with the company. The investment management company managing the fund will invest it according to a specified investment policy to maximise financial returns, given the acceptable risk level.

Tax implications

The tax implications of provident funds vary depending on the type of fund and the circumstances of the withdrawal. Here are the tax implications for the different types of provident funds:

Statutory Provident Fund

• Employee contributions: Deduction allowed under section 80C.
• Employer's contribution: Exempt from tax.
• Lump-sum amount received by employee: Exempt from tax, subject to certain conditions.
• Amendment: If a contribution made by an employee exceeds Rs. 2.5 lakhs in a year, the interest earned on the excess amount will be taxable. If the employer does not contribute, the limit is Rs. 5 lakhs, and the interest on excess contributions will be taxed.

Recognised Provident Fund

• Employee contributions: Deduction allowed under section 80C.
• Employer's contribution: Exempt up to 12% of Basic Salary + Dearness Allowance.
• Interest: Exempt up to 9.5% interest per annum.
• Lump-sum amount received by employee on retirement: Exempt from tax if retired due to ill health, transfer to a new employer, shutdown of the employer's business, or retirement after five years of service. The lump sum is taxable if the employee retires before five years of service for any other reason.
• Amendment: Similar to the Statutory Provident Fund, if an employee's contribution exceeds Rs. 2.5 lakhs in a year, the interest earned on the excess will be taxed. If the employer does not contribute, the limit is Rs. 5 lakhs, and the interest on excess contributions will be taxed.

Unrecognised Provident Fund

• Employee contributions: The deduction is not allowed under Section 80C.
• Employer's contribution: Not taxed when initially contributed or on yearly accrual.
• Amounts received on retirement: Employee contributions, interest on employee contributions, employer's contributions, and interest on employer's contributions are all taxable.

Public Provident Fund

Deduction allowed under section 80C.

Employees' Provident Fund (EPF)

• Employee's contribution: Not taxable. However, if a deduction under section 80C was claimed in previous years, additional tax may be owed.
• Interest on employee's contribution: Taxed as income from other sources.
• Employer's contribution: Fully taxable under the head 'Salary' in the tax return.
• Interest on employer's contribution: Fully taxable under the head 'Salary' in the tax return.
• EPF withdrawal before 5 years of continuous service: TDS (tax deducted at source) will be deducted. If the withdrawal amount is less than Rs. 50,000, no TDS is deducted.
• EPF withdrawal after 5 years of continuous service: Exempt from tax. No TDS is deducted.
• EPF withdrawal by a temporary employee: The period of employment as a temporary employee is not considered for calculating the 5 years of continuous service. The calculation starts from the date the employee becomes permanent.
• EPF withdrawal from an unrecognised fund: Withdrawals are taxed regardless of the length of service.

Voluntary Provident Fund (VPF)

Employees can contribute over and above the minimum contribution to a Voluntary Provident Fund.

Additional Considerations

• Transfer of PF from one account to another upon a job change: No TDS is deducted, and the amount need not be offered as income in the tax return.
• Withdrawal of EPF for specific reasons: If the withdrawal is due to the employee's ill health, the shutdown of the employer's business, or reasons beyond the employee's control, no TDS is deducted, and the amount need not be offered as income in the tax return.
• PAN details: Providing PAN information during withdrawal can reduce the TDS rate to 10%. If PAN is not provided, the TDS rate is 20%.
• Form 15G/15H: Submitting these forms with the EPF withdrawal form can eliminate TDS if the individual's total income, including the EPF withdrawal, is nil.

Fund management when leaving employment

Fund management is an important aspect of leaving employment, especially when it comes to provident funds. Here are some detailed instructions and considerations for managing your provident fund when leaving a job:

Understanding Provident Funds:

Provident funds are government-backed retirement savings plans used primarily in Asia and Africa. Both the employee and employer contribute to the fund, which aims to provide financial support for the employee during their retirement. The government sets the rules for contributions, withdrawals, and eligibility.

Options for Managing Your Provident Fund:

When leaving a job, you have several options for managing your provident fund:

• Leave the fund untouched: You can choose to leave the money in your provident fund and continue to be a member. This option may result in gradually increasing contributions over time, depending on the employer's policy. However, if you terminate the fund without resigning, your employer may decide that no further contributions will be made.
• Transfer to a new employer's provident fund: If you find a new job, you can transfer your provident fund to your new employer's plan. This option simplifies fund management and tracking of retirement savings.
• Roll over to an Individual Retirement Account (IRA): You can roll over your provident fund into an IRA, which offers more investment options and flexibility. This option is ideal if your new employer doesn't offer a suitable retirement plan.
• Withdraw the money: You may be able to withdraw your money from the provident fund, but this option often comes with penalties and taxes. It should be considered a last resort if you urgently need the funds.

Important Considerations:

• Paperwork and documentation: Ensure you update any email addresses associated with your provident fund to a personal email, especially if you are leaving a job.
• Vesting and contributions: Understand the portion of employer contributions that are vested and the terms of contribution. The amount you can take with you may depend on the employer's vesting schedule and your length of employment.
• Tax implications: Be aware of potential taxes and penalties associated with withdrawing or transferring funds. Consult a financial advisor or tax professional for guidance.
• Investment objectives and risk tolerance: Choose an investment plan that aligns with your objectives, risk tolerance, and expected expenses after retirement.

Country-Specific Variations:

It is important to note that provident fund rules and regulations can vary by country. For example, in Thailand, employee contributions to the provident fund are tax-deductible up to 500,000 THB per year. In South Africa, provident fund payouts can be claimed at any age if the individual has been a non-resident for three uninterrupted years. Always review the regulations in your specific country or region.

In summary, when leaving employment, carefully consider your options for managing your provident fund. Seek guidance from a financial advisor or plan administrator to make informed decisions that align with your retirement goals.

Differences between provident funds and pension funds

A provident fund is a government-backed retirement fund, prominent in Asia and Africa, that operates like a mix of Social Security and 401(k)s in the US. It is a government-managed retirement savings plan, where both the employee and employer contribute to a fund that aims to provide financial support to the employee when they retire. Provident funds are generally compulsory, often through taxes, and are funded by both employer and employee contributions. The government sets the rules regarding withdrawals, including the minimum age and withdrawal amount.

A pension fund, on the other hand, is a retirement plan run by employers and governments, providing a retirement benefit to participants equal to a portion of their working income. It is a pool of funds set aside by employers and, often, employees, for the workers' future benefit. The funds are then invested on the employees' behalf, and the earnings help fund the workers' lives upon retirement. Pension funds operate much like annuities.

While provident funds are generally compulsory, pension funds are not. However, both are low-cost, tax-advantaged accounts. In provident funds, the government decides where the money is invested, whereas pension funds may allow individual participants to choose their investments and contribution amounts.

Upon retirement, members of a pension fund may be able to take out their benefits in a lump sum, though it is more common to receive monthly payments. With provident funds, members can take out a portion of their retirement benefits, typically up to one-third, in a lump sum upfront. The remaining benefits are then distributed in monthly payouts.

In terms of tax, pension fund payouts are taxed, whereas the tax treatment of lump-sum withdrawals from provident funds may vary between regions.

Frequently asked questions