So, can a private sector employee generate regular income similar to state pensions using EPF and NPS? The answer is yes. Here is a look at how to do that.
When EPF alone is sufficient
The Employees Provident Fund (EPF) has statutory backing because it has been mandatory for private companies with 20 or more employees to direct part of their salaries towards this regressive saving. So it is one of the most widely used retirement savings options. So, what are your chances of getting a reliable retirement fund if you rely solely on EPF for your retirement savings?
Suresh Sadgoban says, “If one does not withdraw from the IMF, they will accumulate in a large pool. If this is properly invested, one may be able to generate decent income through various sources. It is not necessarily a pension product.” Founder of Ladder7 Financial Advisors.
For example, if you start your job with a base salary of Rs 25,000 at the age of 25 and your salary is growing at 5% per annum, the balance of your personal finance fund at the time of retirement at the age of 60 will be sufficient to get government employees like retirement. As shown in the table below, you will be able to have a regular monthly income of Rs 1.85 lakh which will be half of the last drawn monthly salary of Rs 3.7 lakh and will continue to grow every year and can go on for 30 years in retirement till the age of 90.
When you need to top up your EPF with NPS
EPF may be sufficient for some, however, it may be less than that for many salaried people. For example, if the return earned on the EPF is less than 8% during the remaining working period or there is a possibility that the return on the pension fund will be less than the assumed 7% per year, you may have to look for a larger contribution. Furthermore, if your annual salary growth rate is above 5% (as shown in the table), EPF alone may not be enough. Higher salary growth could mean that your last salary withdrawn will be much higher, and therefore you will need a much higher regular income, and therefore you will need to accumulate a much larger retirement pool. This is where another retirement savings tool, the NPS, comes to your rescue.
“This has to be properly planned. People should realize that retirement is an important stage in life where one requires a sustainable income. Hence, if people have contributed diligently during their working life to EPF and NPS, they will surely have enough of corpus to enable the formation of a regular income,” says Sadagopan.
For example, if you start a job with basic salary or Rs 25,000 at the age of 25 and if it grows at a rate of 10% per annum, the required retirement pool for government employee such as pension will be Rs 9.75 crore (see table). But your EPF pool will be only Rs 4.73 crore. In such a scenario, if you contribute Rs 5,441 per month in addition to your EPF deduction and increase it with the same percentage of your salary increase, you will be able to create a retirement pool of Rs 5.02 crore through NPS if the annual return is 9%.
NPS Boosts Net Income With Additional Tax Savings
There is no substitute for the tax saving opportunity available on NPS contributions. This becomes an effective tool for people who fall into the higher tax categories to not only enhance their pension fund but also supplement it with additional tax savings.
says Richard Manekia, founder and managing director, Kairos Capital.
If you add this tax savings to your NPS return, the net return will be much higher. “Any additional tax savings helps increase your net return. Therefore, the additional benefit one gets because of investing in an NPS boosts your after-tax return. Not only do I think tax benefits, but you should also look at NPS as an additional way to save money for retirement income,” says Santosh Joseph, founder and managing partner of Germinate Investor Services.
What if you exhaust your EPF balance mid-career
There are a large number of people who either have no EPF savings or have very low mid-career balances. In such a scenario, additional investment in a Voluntary Provident Fund (VPF) may be very beneficial.
“VPF makes up a very good part of a person’s portfolio and savings, especially for investments. We know that in allocating assets for retirement, it is good to have a certain amount of fixed income or debt, so VPF makes up this part very well in addition to that, since it is also A long-term debt investment with a tax advantage and also a good interest rate in the given scenario, it is a good idea to consider a VPF to strengthen the retirement fund,” says Joseph.
Besides VPF, you may consider other options as well. “VPF can be an option, as it gives fixed returns and a tax deduction also under Section 80C of the Income Tax Code. However, one has to compare it to other avenues such as mutual funds, which offer flexibility and have the potential to give better returns in the long run,” Manekia says. For example, people in the 40-50 age group have more than 10 years on hand and can therefore use equity to support their retirement savings.
Investing for inflation after retirement is a must
One of the common mistakes most people make while saving for retirement is the body’s ability to offset inflation by regularly increasing regular income. “The state pension will be adjusted in terms of inflation and it will also go up with the wage commission,” says Sadagoban. “It will not happen here and thus one needs to be careful while accumulating and preparing income.”
Therefore, the pension system must either be large enough that it can offset inflation or it must earn a higher return. “Depending on the risk appetite, a portion of the retirement pool can be invested in equity-oriented instruments such as mutual funds,” says Manekia.
If you are not comfortable with the idea of investing part of your retirement pool in stocks, you will have to do so early on during the accumulation phase to support your retirement system. “The sooner you do it, the better because over a period of time the risks in growth-oriented assets like stocks and real estate offset the risk. So, it’s a good idea to start soon, start early, start early,” Joseph.