You’re probably thinking your EPF interest is completely tax-free, right? Think again! Many salaried Indians are in for a rude awakening, as Budget 2021 changed the rules, and it could be costing you more than you realize.
The Hidden Tax Trap: Exceeding the ₹2.5 Lakh Limit
For years, the Employees’ Provident Fund (EPF) was considered a golden goose for retirement savings—contributions from both you and your employer, earning interest, all tax-free. But those days are largely over.
“People still assume all EPF interest is tax-exempt, but that’s no longer true,” warns CA Himank Singla. He recently encountered a case that perfectly illustrates this overlooked tax trap.
Consider one of Singla’s clients: earning ₹3 lakh per month, he contributed the mandatory 12% of his basic pay to EPF (₹72,000 annually). But he also contributed an additional ₹3.28 lakh through the Voluntary Provident Fund (VPF). This brought his total employee contribution to a hefty ₹4 lakh for the year.
Here’s where the new rule bites:
- From FY 2021-22 onwards, interest earned on employee contributions exceeding ₹2.5 lakh per year is now taxable under “Income from Other Sources.”
- (For government employees with no employer contribution, the threshold is higher at ₹5 lakh.)
In our client’s case, ₹1.5 lakh of his contribution (₹4 lakh – ₹2.5 lakh) exceeded the tax-free limit. With an EPF interest rate of about 8.25%, this generated approximately ₹12,375 in interest that became taxable.
“And it’s not just taxable,” Singla added. “It’s also subject to TDS if thresholds are crossed and must be reported in your ITR under ‘Income from Other Sources.’ People think it’s safe in the EPF account, but that doesn’t exempt it from tax.”
What You Need to Know to Protect Your Retirement Nest Egg
This limit applies only to your employee contributions. Employer contributions have their own combined ceiling of ₹7.5 lakh annually across EPF, NPS, and Superannuation Funds, with interest on any excess also being taxable.
The takeaway for every salaried employee is clear:
- Track Your Contributions: Keep a close eye on your combined EPF and VPF contributions.
- Stay Under the Limit: Aim to keep your annual employee contributions below ₹2.5 lakh if you want to enjoy fully tax-free interest.
- Understand New Accounts: EPFO now maintains separate taxable and non-taxable accounts to help manage this.
EPF remains one of India’s safest retirement tools, but its tax-free status now comes with significant conditions. If you’re someone who maximizes VPF contributions, careful tax planning is no longer optional—it’s essential to avoid unexpected tax liabilities.
Good news: The PF amount you withdraw at retirement is still tax-free, provided you’ve made continuous contributions for at least five consecutive years.
Are you tracking your EPF contributions closely enough?