The reduction in interest rate on employee provident fund deposits underlines the need for the salaried class to start retirement planning early in the career and consider a diversified portfolio to invest their savings, say experts.

“The magic of compounding works wonders in terms of quantum of savings and helps limit (to some extent) the effect of lower returns on some plans in some years,” said Preeti Chandrashekhar, India business leader – health and wealth at Mercer India, on why it is important to start early.

An estimated 64 million members of the Employees’ Provident Fund Organisations will be affected by the recommendation of its central board of trustees to cut the interest rate to 8.1%, the lowest in four decades, from 8.5% for the last fiscal year, due to market pressures.

The reduction impacts the accumulation of the retirement corpus, with high inflation bringing down the real returns further.

Experts say the rate reduction wasn’t a surprise. Some of them suggest the National Pension System (NPS) as one of the alternatives to build a corpus for retirement.

“This was inevitable; the previous rates weren’t sustainable,” said Rituparna Chakraborty, cofounder, TeamLease Services. “Now employees will realise they can’t only bank on the EPF … they will be nudged towards a more diverse portfolio including alternate products like the NPS.”

The pandemic has exposed the financial fragility of employees and there is an increased interest in financial, in particular retirement, planning, said Mercer’s Chandrasekhar.

The NPS is gaining popularity. The number of subscribers in various schemes under the NPS rose 22.31% in a year to more than 50.72 million as of end-February 2022, according to the Pension Fund Regulatory and Development Authority (PFRDA), in a clear signal that people are looking at multiple resources for retirement planning.

However, EPF will continue to be one of the most appealing retirement savings vehicles, primarily due to the tax-efficiency at the contribution, investment/accumulation and maturity stages. Even though recent tax changes imply that interest on contributions of more than Rs 2.5 lakh a year is taxed, EPF still is attractive for most subscribers, said Chandrasekhar.

According to Meghesh Nandi, associate director, consulting at Deloitte India, one of the reasons for EPF to remain a popular investment tool was that alternatives such as the NPS were market-linked (even though the compound annual growth rate for the last five years on Scheme E tier 1 has been around 14%).

“The PFRDA chairman has suggested that a guaranteed return from the NPS is in the works. Until that gets introduced, individuals, especially those with a lower risk appetite, would definitely continue to keep their allegiance with EPF rather than a market-linked pension scheme,” said Nandi.