PPF, EPF, VPF, Ulips are some of the popular tax-free investment options available to investors. Going forward, interest income from the voluntary provident fund (VPF) and gains in Ulips will be subject to tax provided the specified investment limit is breached.
In the case of employees who contribute more than Rs 2.5 lakh per annum towards employees provident fund account or the voluntary provident fund, the interest income earned will be fully taxable in the hands of the employee. This will be effective on contributions made from April 1, 2021. Some employees contribute more than the mandatory 12 per cent towards PF. The PF rules allow that but it is not mandatory for the employer to match that additional contribution. Employees opt for VPF to earn a safe and tax-free return on their additional contributions.
As of now, the entire PF contribution towards EPF or VPF earns tax-free return and the PF amount enjoys EEE status. Going forward, if your monthly Basic Salary is above Rs 1.75 lakh ( just the basic salary and not your total monthly income), your monthly contribution will be above Rs 20,835, which is Rs 2.5 lakh in a year, then the interest income earned on the exceeded amount is taxable.
For example, for someone with a Basic Salary of Rs 1 lakh, the monthly contribution is Rs 12,000 which is about Rs 1.44 lakh in a year. The employee contributes an additional 12 per cent into VPF taking the total contribution to Rs 2.88 lakh in the year. In such a case, the interest earned on Rs 38,000 (excess of Rs 2.50 lakh) will now get taxed.
The new PF contribution rules will not impact an employee whose monthly contribution is below Rs 20,833. However, if your Basic Salary is above Rs 1.75 lakh, there’s no escaping tax on interest earned. The only way out is if your employer provides you with an option to divert contribution to NPS.
Similarly, in the case of ulips, if the premium is more than Rs 2.5 lakh per annum, there will be levy of long term capital gains tax of 10 per cent, if the gains exceed Rs 1 lakh in a year. Such Ulips will have the definition of equity-oriented fund in section 112A so as to provide the same treatment as a unit of equity-oriented fund. Thus provisions of section 111A and 112A would apply on sale/redemption of such Ulips. This will be effective on ulips purchased from February 1, 2021.
Before the new Ulip rules, the fund value on maturity irrespective of the premium amount was tax-free. Even now, tax exemption shall be available under Section 10(10D) only for maturity proceeds of the Ulip having annual premium up to Rs. 2.5 lakh. The total premium across multiple policies in the name of the same policyholder will be considered for tax purpose.
Therefore, investors need to be careful when saving more than Rs 2.5 lakh per annum in Ulips and VPF during the year. Besides returns, the income tax plays an important role in creating wealth over the long term. Not all investments generate tax-free income and the income earned is subject to income tax based on one’s tax-rate. The post-tax return is an important factor that investors need to consider before selecting any investment option.