New PF rule: You may have to relook retirement saving plan

A recent circular about the manner in which the contribution to the Employees Provident Fund will be calculated will have far reaching impact on employees in the days to come. In a nutshell the manner of calculating the base for the application of the rate of deduction of provident fund contribution should include the basic salary, dearness allowance as well as allowances that are ordinarily, necessarily and uniformly paid to employees instead of the basic salary and dearness allowance that is used currently for the calculations. Here are some of the impacts that will be witnessed in the days to come.

Additional
provident fund contribution:

One impact of the implementation of this change will be that the contribution to the Employees Provident Fund will increase on the part of both the employer and the employee. This will happen as the base for the calculation is larger than before due to the increase in the items that are considered as basic wages.  For the employee this will mean that a larger amount gets accumulated in the provident fund account each month which will mean a larger amount of earnings in the form of interest in the coming time period.  This will change the entire dynamics of the retirement planning calculations as this larger amount going towards this area will need adjustments in terms of savings and investments in other areas for the purpose of retirement planning.

Change in salary structure:

The amount spent by an employer on the employee is known as cost to company and when the change in the manner of provident fund contribution is considered if all other things remain as before then it will lead to a larger contribution from the employer. If the employer decides to absorb this rise then it will in effect be a salary hike for the individual to the extent of the extra amount contributed to the provident fund by the employer. However many employers might prefer to keep the cost to company figure constant by reducing the allowances to the extent that this compensates for the additional amount of contribution to the provident fund. This would lead to changes in the salary structure and in many cases even the manner in which the entire salary is provided.

Cash flow:

A major impact for the individual will be the cash flow changes that will be witnessed. A larger contribution to the provident fund from the employees side will mean that lesser amount of income will be available as take home salary.  This can put a severe dent in the management of the household budget because the individual will have to adjust their planning in such a way that the lower amount of income is taken into consideration for the various spends. If the employer decides to change the salary structure by reducing the allowances to keep the cost to company figure constant then the hit will be even harder as the income will fall and at the same time contribution will rise leading to a squeeze on the cash flow from both sides. Planning for a reduced take home salary in advance would be required to avoid a sudden shock later on.

Overall planning:

The overall planning with respect to investments and long term retirement needs will need to undergo a change for the employee. With a larger amount being compulsorily going towards retirement needs the individual might need to shift their overall planning focus to other areas. This could require allocation for other goals like education of children, buying a property, travel etc. There is also the question of the rate of return being earned by the investments and since the interest earned on provident fund is tax free it will be difficult for the investor to get similar rates on the debt side from other instruments. So the allocation towards provident fund would be earning a good rate of return and the remaining funds would need an appropriate asset allocation so that an overall balance in the portfolio is maintained for the employee