PF withdrawal vs transfer: What you should do

Retirement is an important phase in one's life. It changes the dynamics of our financial life in the view of change in cash flows. The actions we take during our employment, determine the corpus we build for our retirement phase. Employees' Provident Fund (EPF) is one of the traditional routes to save for our retirement. Our contributions towards EPF can help in building a substantial retirement fund. However, one drawback with these contributions is that any premature withdrawal of EPF is allowed under certain special circumstances. Below mentioned are some advantages of why it is not advisable to withdraw the EPF contributions. (Also read: Changing jobs? 5 tips on transferring PF)

Retirement is an important phase in one's life. It changes the dynamics of our financial life in the view of change in cash flows. The actions we take during our employment, determine the corpus we build for our retirement phase. Employees' Provident Fund (EPF) is one of the traditional routes to save for our retirement. Our contributions towards EPF can help in building a substantial retirement fund. However, one drawback with these contributions is that any premature withdrawal of EPF is allowed under certain special circumstances. Below mentioned are some advantages of why it is not advisable to withdraw the EPF contributions. (Also read: Changing jobs? 5 tips on transferring PF)

Opportunity cost - interest accumulation
The interest on the contributions towards provident fund (PF) is compounded on an annual basis. This means that the interest earned during this year is added to the principal and we can generate interest on previous year's earnings as well. This is a called the power of compounding. Any withdrawals from the EPF contributions result in losing out on the benefits of compounding. Even in the case of a job switch, it is always advisable to transfer the EPF account rather than withdrawing the amount. It helps in building a substantial corpus with power of compounding working in favor of those individuals who continue with the account rather than withdrawing the amount.
 

Impact on retirement savings
Contributions to provident fund account for a substantial amount towards our retirement fund. Withdrawing the accumulated corpus while switching the jobs or for other reasons can reduce the retirement corpus significantly. In order to compensate for this deficit, one has to make higher savings in the future or opt for riskier investments. Consider the case of an individual who is 35 years old and expects to retire at 60. If he withdraws Rs 5 lakh from his PF account now, it will create a deficit of around Rs 38.43 lakh in his retirement corpus. In order to compensate for this amount, he should start investing Rs 18,607 per month at 10 per cent rate of return starting at the age of 50. This translates to total investment of around Rs 22 lakh. So, in order to compensate the deficit created by a provident fund withdrawal, one should invest higher amounts at a later stage.

Tax impact
Subject to few exceptions all kinds of withdrawals from PF account are taxable if carried out before five years of continuous service. In such cases, PF withdrawal is taxed in the following manner:

• Payment received from employer and interest accrued to the extent is treated as a part of the salary and is taxed accordingly.
• Interest accrued on our own contribution to the PF account is taxed as other income.

For example:  Consider the case of a person who has worked for 4 years in an organization and has accumulated Rs 3 lakh as PF account balance. His taxable salary after deducting the general exemption of Rs. 2 lakh is Rs. 4.5 lakh. As per the income tax slab he needs to pay taxes at the rate of ten per cent. But if he resigns from this organization and opts to withdraw PF account balance then he automatically moves into the next income tax slab for that particular year. However, there is no tax on transfer of the PF account to the new employer thus protecting the growth of this fund for a secure future of finances at the time of retirement.

For a stress free retirement we need to treat the continuity of our provident fund contributions seriously. Premature withdrawal has to be considered only after critically analyzing the cost benefit analysis and should only be made when we have no other option.

ArthaYantra provides personal finance advice online.
 

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