So, the once in a century budget is out. If you have been in touch and wondering what is ‘once in a century’ about it, let me share with you the popular humour.
There were no new taxes!
Ah! Perhaps, that is a little stretched. It may be true for a large section of the population but some of the top taxpayers have a crib.
Your EPF – VPF contribution is less attractive now
One of the smart moves used by several high tax bracket individuals was to make additional contributions to the Voluntary Provident Fund (VPF). It enabled them to earn a tax free return – same as the Employee Provident Fund (EPF). The rate for last year was 8.5%.
The budget 2021 changes this a bit. For all contributions made by employees (not employer), which exceed Rs. 2.5 lakhs in a year, any interest earned on this excess amount will be subject to regular taxation.
Let me explain.
Suppose, your EPF contribution per month is about Rs. 20,800. Now, given your conservative nature and need for assured returns, you start adding Rs. 1 lakh per month via the VPF. That is Rs. 12 lakhs a year.
Since, this Rs. 12 lakhs contribution to VPF is more than Rs. 2.5 lakhs of EPF+VPF combined, any interest earned on the same will be subject to tax.
Let’s further assume that you earn an 8% interest on this Rs. 12 lakhs, that is, Rs. 96,000. If you happen to be in the 30% tax bracket, you will now pay Rs. 96,000 * 30%, or, Rs. 28,800 as tax.
If you are in the 20% tax bracket, you will pay Rs. 19,200 as tax. If you are in the 40%+ tax bracket, well, you know what to do.
This is similar to the tax you pay on your Bank Fixed Deposits.
Now, before you start thinking of it as a loot and backstabbing and the ‘they just want to squeeze the salaried middle class‘, please note that this provision is applicable only for contributions that you will make starting on or after April 1, 2021.
Based on the current understanding, any balances in EPF that you will have till March 31, 2021 or interest earned on them in the future are exempt from tax.
The contribution limit of 2.5 lakhs a year is combined on the Statutory contribution of 12% of the basic + any VPF contributions. It does not include Employer contribution.
Should you stop your VPF contributions? Well, that depends on what impact you are willing to absorb for the certainty of the return. If you have an advisor, speak to him/her to see what will work for your financial situation.
Read : Retirement Planning – Who cares?
What about ULIPs?
Well, you all know our take on ULIPs. The Budget 2021 attempts to bring some parity to taxation of ULIPs and other similar investments such as Mutual Funds.
If you take a new ULIP on or after Feb 1, 2021 and the annual premium is Rs. 2.5 lakhs or more, then you are liable to pay capital gains tax on maturity of such a ULIP.
Note, payout in case of death continues to be tax exempt.
A quick note about Dividends
If you have investments in direct stocks or mutual funds where you have opted for dividend option, then the applicable TDS has been removed. You will now receive the full amount in your hands.
However, you will need to compute any tax liability (based on your total income and tax bracket) and pay advance tax on such receipts.
“Let’s further assume that you earn an 8% interest on this Rs. 12 lakhs, that is, Rs. 96,000. If you happen to be in the 30% tax bracket, you will now pay Rs. 96,000 * 30%, or, Rs. 28,800 as tax.
If you are in the 20% tax bracket, you will pay Rs. 19,200 as tax. If you are in the 40%+ tax bracket, well, you know what to do.”
I believe the entire interest is not taxed, only the interest on the amount that exceeds 2.5 lakhs
Yes, the 12 lakhs has been considered as the excess investment.
For the 2nd year, this Rs.96,000 would also earn interest. What would happen to that and interest earned in subsequent years?
In my view, the interest earned next year as well as interest on interest will be taxed in that year.
In such a situation, how to keep track and whether employee will calculate and deduct the tax or individual has to do this exercise?
Those operational details are yet to come out.