Find out what the 2021 budget means for retirement planning and investing

A provident fund (PF) has been one of the most common ways for salaried people to build a retirement corpus, in which both the employer and the employee contribute a certain percentage of salary. An employee's contribution to PF is deductible up to INR 150,000 under Section 80C of the Income Tax Act of 1961.

Any accumulated balance due and becoming payable to an employee participating in a recognized provident fund, upon retirement with interest, is considered tax-exempt under the Act, provided the employee has provided continuous service for 5 years or more.

The 2021 Budget proposed an amendment to this provision that any interest income accrued during the previous year in the PF, to the extent that it relates to the employee's contribution exceeding 2.5 lakh in the previous year, would be subject to taxes in the hands of the employee. The purpose of this proposed amendment is to limit the benefits of tax-free interest to high-income individuals.

It is important to note that the Finance Act 2020 has amended the definition of salary to establish the employer's contribution to the provident fund in excess of INR 7.5 lakh and the interest on it will be considered a taxable prerequisite for employees.

This current ammendment will further affect the retirement corpus because PF returns will not be completely tax-exempt on a prospective basis. This interest income will be taxed at the applicable slab rates against beneficial tax rates of 10% or 15% in the case of other investments in the capital market. 

Considering this, people should look at each investment/savings option from a tax perspective to ensure maximum returns and the maximum amount of disposable funds in their hands at retirement.

Invest in stocks and mutual funds

The 2021 Budget proposed a significant ammendment by placing Unit Linked Insurance Plans (ULIPs) under tax bracket. At present, the redemption of the ULIPs is tax-exempt as long as the total premiums to be paid for the policy do not exceed 10% of the guaranteed amount.

However, Budget 2021 suggested taxing the redemption value of ULIPs issued as of February 1, 2021, as the premium paid by an individual exceeds INR 2.5. It is proposed that such ULIPs be treated as “capital assets” subject to capital gains tax at par with equity-oriented mutual funds.

This amendment will affect High Net Individuals HNI's investment planning as ULIPs will now be on par with other equity-oriented mutual funds. The market will see a shift in ULIP's investments to equity-oriented funds.

At this stage, investors should carefully evaluate other factors before choosing any of the market-linked investment options, such as liquidity, the applicability of exit load, the flexibility to switch from equity to debt plan. or vice versa, lock-in period, etc., proposing a tax on the interest income from PF funds will also convert PF fund investments into other market-related investments where the tax rate is as low a 10% on long-term capital gains compared to applicable slab rate tax.

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