Subscribing to Provident Fund has been a very easy and popular method to accumulate savings for retirement and long-term financial objectives. The tax benefits on returns from such savings is a big incentive. But this has changed with the budget announcement to tax income from savings over ₹ 2.5 lakh in Provident Funds (₹ 5 lakhs where employer does not contribute). It is a fair assumption that those who intend to save more than this ceiling will also be in the relatively higher tax bracket. It is therefore imperative to look for suitable alternatives to Provident Fund which can provide most of the desired features.
Features of Provident Fund
The scan for alternatives can be meaningful if we understand the key characteristics that we are looking for.
Risk
Savings in Provident Funds are guaranteed under government regulations and therefore the capital is safe. The alternative should also provide a high degree of safety of capital.
Returns
The returns from savings in provident fund are based on the overall returns of the Pension fund and its paying capacity. Empirical evidence suggests that it is generally above the inflation rates. The returns from the alternative should also be above inflation rates.
Tax Liability
The entire interest on Provident Fund Savings so far was tax-free. It is not possible to find an alternative which will give tax free returns with the desired security. The alternative should however have a lower tax liability as compared to the tax slab of the investor.
Liquidity
Part withdrawal from Provident Funds after initial years is reasonably easy. The alternative should also have comparable liquidity.
Ease of Investment
Subscription to Provident Fund is hassle free and mostly automated. The alternative investment option should also be simple to execute.
Alternatives to Provident Fund
As safety of capital is of paramount importance, pure equity options are not suitable alternatives. A scan of other products in the market indicates the following options for evaluation.
NPS
National Pension System is a good avenue to save additional tax. All those who were not subscribing can open an account now and benefit by contributing up to ₹ 50,000/- every year. The other details have been discussed earlier in NPS-Additional Tax Saving with Customisable Returns.
PPF
Public Provident Fund also remains an attractive option. The present ceiling of subscription is ₹ 1.5 lakh per annum per adult’s account. So far there is no mention of including PPF accounts in the ceiling of ₹ 2.5 lakhs /₹ 5 lakhs for earning tax-free returns. This is the closest alternative to other Provident Funds.
Fixed Deposits
It is a simple option to execute. There is negligible risk but the returns are low as compared to Provident Fund. There is no tax advantage. The capital is also locked as per the chosen tenor. Continuing subscription to the Provident Fund despite tax liability is a better option as compared to FDs.
Debt Mutual Funds
The arena of Debt Mutual Fund is very large and they offer a range of options with reasonable balance between risk and return. The risk ranges from almost zero in the case of Gilt Funds (Government bonds) to the significantly higher levels in the case of Credit Risk Funds. As limiting risk is an important consideration for suitable alternative, we can reduce the scope to only Gilt Funds and Corporate Bond Funds investing in high (AAA) rated bonds. The returns are likely to be higher than Fixed Deposits. The returns are taxable, but after three years they qualify for Long Term Capital Gains at reduced rates (20%). Benefit of indexation is also available after three years. Liquidity is high as one can withdraw funds at any time.
The available financial technology infrastructure permits investment in Mutual Funds with great ease. Investment in Debt Mutual Funds through monthly Systematic Investment Plans (SIPs) appears to be a very good alternative to Provident Fund.
Gold
Historically Gold has proved to be a good hedge against inflation with marginal real returns. Over long periods it has negligible downside and provides very easy liquidity. The Sovereign Gold Bonds (SGB) also offer tax benefits on maturity. Govt also pays interest (presently 2.5 %) which is taxable. There are other options to invest in Gold like Gold Mutual Funds and Gold ETFs etc which have been discussed in Gold-Is it a Good Investment Option?. Though not similar, but Digital Gold offers most of the features that one is looking for in an alternative to Provident Fund. It is also an important component in a well-diversified portfolio. Some part of the excess savings can therefore be diverted to investments in Gold.
REIT
Real Estate Investment Trusts are a relatively new product in the financial markets. Though modelled like Mutual Funds they have some distinct characteristics. The underlying asset broadly is physical real estate. The returns are in the form of rental income and capital appreciation. Under strict regulation, the trust must give 90% of the distributable cash flows to its investors at regular intervals. The investment is treated as equity for the purpose of classifying short term capital gains and long-term capital gains with tax liability of 15% and 10% respectively. The underlying asset provides good prospects of long-term growth and real estate is also an important component of a balanced portfolio. The digital nature and unit-based holding offers easy and calibrated liquidity.
It must be noted that there are no exact alternatives for a Provident Fund which can give complete safety with tax-free returns. But subscribing beyond the laid down tax-free ceiling would mean overdoing the safety part at the cost of returns. Despite having potential for higher gains and growth, classic equity has not been discussed here due to its volatility and possibility of capital erosion.
Recommendations
- NPS and PPF Subscriptions are the best alternatives up to the laid down tax-free ceiling of ₹ 50,000/- and ₹ 1.5 lakh respectively.
- Debt Mutual Funds investing in Government bonds and high rated corporate bonds are the best alternative to Provident Fund.
- Gold is a good hedge against inflation and provides decent growth. High liquidity and safety in addition to this make it an important element in any balanced portfolio.
- REITs are a convenient route for investment in real estate. The equity like structure and regular income apart from potential capital appreciation make it an attractive add-on to the portfolio.
- Subscribing to Provident beyond the tax-free ceiling is not advisable.
5 replies on “Alternatives to Provident Fund”
Thank you Sir, a very informative and useful article. Regards
Thanks for the informative article. It provides a way ahead to the salaried class people, who are looking for some alternative for savings / investment.
A practical guide for alternatives to PF investment. Very informative and useful. Thank you.
Thanks a lot Rajeshji for insights about REIT and PPF.
Dear Rajesh
Very informative article based on a thorough research. Will benefit a lot of people. Enjoyed reading it.
Thanks and regards