Tax Implications Of Provident Fund & How To Save Tax
Provident Fund or PF is a tax-saving retirement scheme that offers a safety net upon retirement to employees who invest in it. But in certain cases, the interest and PF withdrawal are taxable. This post helps you understand PF taxability rules, types of PF and their tax implications and how to save taxes. Read on!
What Is PF and How Is It Taxed?
Provident Fund is a Government-managed benefit-based scheme meant to secure the retirement of salaried employees. Both employers and employees contribute towards this equally (12% of the employee’s basic salary).
If an employee withdraws the PF amount upon maturity, the entire amount is eligible for tax exemption. On top of this, the exemption also applies to beneficiaries who work for five continuous years and withdraw an amount.
However, individuals will have to face a TDS (Tax Deducted at Source) deduction at a rate of 10% if they withdraw more than Rs. 50,000 without completing five years of service. There is no TDS on withdrawal amounts of less than Rs. 50,000.
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Types of PFs and their Tax Implications
- Statutory Provident Fund
The statutory Provident Fund (SPF) was established under the Provident Funds Act, 1925. Government, semi-government agencies, local authorities, universities, railways, etc., manage this fund. In this scheme, both employers and employees can contribute. However, private-sector employees do not qualify to avail of benefits under SPF.
In terms of tax treatment, any contribution from both parties is tax-free. On top of this, an employee’s contribution will be eligible for tax benefit under Section 80C of the IT Act.
Furthermore, as earnings from this scheme are not considered income, interest accrued is also tax-free. Lastly, one does not have to pay taxes on withdrawal of the full amount after retirement.
- Public Provident Fund
Public Provident Fund (PPF) serves the general public of India. Its objective is to promote small savings and offer guaranteed returns to any Indian resident. One has to simply open an account and deposit Rs.500 to Rs.1,50,000. However, note that PPF has a lock-in period of 15 years.
As only a resident contributes to this scheme, tax exemption applies to any withdrawal after maturity and interest accrued. Furthermore, contributions made by the individual qualify for tax deductions under Section 80C.
- Recognised Provident Fund
Established under The Provident Fund Act, 1952, Recognised Provident Fund (RPF) is the most popular type of provident fund in India. Any recognised establishment with 20 or more employees can become a beneficiary of this scheme. One can either apply for the government-approved scheme or create a PF scheme by forming a trust as per rules of PF Act, 1952.
Earlier, any contribution of the employer above 12% of the salary was taxable. However, the Union Budget of 2020 made contributions from employers above Rs. 7.5 lakh in a financial year taxable in the hands of employees.
Furthermore, the Central Board of Direct Taxes issued a notice on August 31, 2021, changing the tax implication on interest accrued, which will be applicable from April 1, 2022. Now, if the interest on PF contribution is over the threshold limit of Rs. 2.5 lakh, it is subject to tax. But if only an employee makes contributions, the limit increases to Rs. 5 lakh.
Lastly, tax is not imposed on lump sum withdrawal if one retires after 5 years of service or due to health issues, or shutting down of business.
- Unrecognised Provident Fund
Any provident fund scheme that does not fall under the above three categories is part of the Unrecognised Provident Fund (UPF). Specifically, UPF is a PF scheme that does not get the approval of the Commissioner of Income Tax. In the case of this fund, the tax implications are the most complicated.
Unlike the other PFs, employees’ contributions are not eligible for any tax deduction under Section 80C. Nonetheless, the employer’s contribution to PF and interest accrued on the total amount remain tax-free.
Treatment of the amount withdrawn upon retirement is done in the following manner:
- Employer contribution: Taxable under ‘Income from Salary’
- Interest on employer’s contribution: Taxable under ‘Income from Salary’
- Interest on employee’s contribution: Taxable under ‘Income from other sources.’
- Employee contribution: Not taxable
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How to Save Taxes?
Despite Provident Funds being one of the most sought-after investment options because of their tax benefits, you can still take some precautions to save taxes further.
PF subscribers should pay close attention to the threshold limit. If individuals know that their contributions will exceed the limit, they should look for an alternative and a more suitable investment plan.
Furthermore, individuals should refrain from withdrawing money from their PF account before maturity or 5 years of service. For the latter, they can avoid paying 10% TDS by making a withdrawal with Form 15G/15H.
Final Word
After working for years, one deserves to enjoy a secure and happy retirement. Investing in Provident Funds helps salaried employees fulfill this aim. PF schemes are known for their tax-saving benefits, but one should pay attention to the PF taxability rules to make a calculated investment decision.
FAQs
You can withdraw the full amount from your PF account before retirement but only in certain cases. If a beneficiary remains unemployed for one month, he/she can withdraw 75% of the amount. However, if unemployment continues for one more month, the person can withdraw the remaining 25%.
While making partial or advance withdrawal from the Provident Fund account, one uses Form 31. The amount one can take out varies as per the reason for withdrawal. Nonetheless, subscribers can only use this form for withdrawals with a valid and justified reason.
There are four types of Provident Funds that serve various purposes and are subject to different taxes. Amongst the four, the contributions and interest accrued on Statutory Provident Fund and Public Provident Fund are not taxable. However, one will have to pay tax on premature withdrawal.
As per the current Indian Provident Fund (PF) law, once an employee retires, the PF account will become inoperative if one does not withdraw full amount within 36 months. Interest will continue to accrue till 36 months, but you cannot make any contribution.
Even though the PF account becomes inoperative after 36 months of retirement, you can keep your funds in it as the account remains open. However, you will have to pay tax on the interest earned post three years of retirement.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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