Very soon you will be able to track the equity investment in your provident fund account. The Employees' Provident Fund Organisation (EPFO) last month announced that it would credit exchange traded fund (ETF) units in the provident fund account of subscribers. This means, the equity component of your EPF money will get unitized and you will not only be able to track your EPF investments in equities but also realise the gains from the stock market at the time of withdrawal. At our end, this will need a major software change because the EPF account of the subscribers will get bifurcated into two accounts: one will be the cash account, in which interest will get credited each year like it happens even now, and the second will be the ETF account in which the subscribers will be able to see the units they hold and the NAV (net asset value) of that day. This is a substantial task and we are hoping to ready our software for an implementation date of 1 April
The EPFO decided to invest in the stock markets in 2015 but till now you have not reaped the benefits of that move because, though EPFO had put money in the stock markets (initially 5% of the incremental corpus, and now it plans to make it 15%) it had not devised a methodology to account for the returns from these investments. The gains, therefore, had been notional and didn't reflect in the interest rate declared. But that's going to change, hopefully from the next financial year.
The EPFO is yet to come out with the finer details on how this will pan out, but this is what we know so far.
The EPF story thus far
The EPFO decided to put money in the stock markets to improve long-term returns and for this it chose to invest in the ETFs. An ETF is a basket of securities that tracks the stock prices of the companies of an underlying index, and is traded on the stock exchanges.
Being a passive fund, an ETF not only comes with a much lower expense ratio but also obviates the fund manager risk to your investment.
Currently, EPFO's investments in ETFs are managed by SBI Mutual Fund and UTI Asset Management Co. Ltd. UTI Mutual Fund manages 10% of the corpus and SBI Mutual Fund manages the rest. Both these fund houses manage Nifty and Sensex ETFs.
Even as the EPFO started putting money in ETFs, it wasn't able to pass on the benefit to the subscribers (that is, you) as the gains were notional and in order to pass on the gains, it would have had to sell the ETF units. In fact, even this year, the EPFO will not be able to pass on the gains from its equity investments.
What happens to your money that went in the markets?
We are yet to take a decision on how we will retire the current equity corpus to distribute gains. Some of the employees who have left the workforce have already withdrawn their money; so it's difficult to arrive at a methodology to retrospectively pass on the differential equity gains which may come at different times. But having said that, the interest rate that we have credited has been on the total contributions of the subscriber and not only on the portion that was not invested in the stock market
The decision to invest in equities—without having a methodology to realise the gains from equity—means that you have neither benefitted nor lost in any way from the equity investment. It remains to be seen how EPFO will account for equity investments. There are limited options really. EPFO could realise the gains and pass off the benefits in the interest rate declaration for FY18 or it could unitise the corpus and credit it into the accounts of employees as opening balance. As for employees who are out of the system, there could be a one-time offer to come and claim the money, failing which the money could go to senior citizens' fund
It is not as if the EPFO had never made any effort at devising a methodology. In 2015, it had come out with a methodology for realizing the equity gains, but this method did not meet the accounting standards of the Comptroller and Auditor General of India (CAG). You can read more about it here: bit.ly/2zSBSdv.
Subsequently, the EPFO reached out to the Indian Institute of Management (IIM) Bangalore, to devise a methodology. The report was submitted by two IIM professors who recommended unitising the corpus. Equity investments are valued on MTM (mark to market) basis and gains or losses are recognized in MTM reserve, as it is not realized. Units are allotted to investors based on NAV and this ensures fairness to investors who enter into the scheme at different points of time," said the report. It also recommended creating a reserve.
As an additional precaution, we suggest creating an equalization reserve out of MTM gains beyond a threshold level, if required, to protect subscribers from misfortunes of entering at the wrong time in the market. This can be created indirectly by allotting lesser units at the entry. In other words the report suggests that in a good year, some of the gains can be retained to create a reserve.
However, as per Gopal, this can be counter productive. Equity investments need to be ready for ups and downs. Reserves in the past have been used to announce higher interest rates as a populist measure, which creates a moral risk. The EPFO has accepted the proposal to unitise the corpus and is now working towards implementing it.
Two EPF accounts
The implementation will require splitting your EPF account into two accounts. The first will be a cash account, which will get credited in the interest declared by EPFO every year. The second will be an equity account, which will show the units you hold and their NAV, just like in the case of mutual funds. There are two fund managers managing ETFs and the customers don't get to decide who they want. The money is invested conforming to investment guidelines. Customers will only need to concern themselves with the consolidated NAVs and the units that they hold
But keep in mind that the rules governing EPF will apply to your equity account too. This means, you need to transfer the equity account as well when you change jobs and you cannot withdraw from it unless you have been unemployed for 2 months. You can also make partial withdrawals from it—for specified life events such as constructing a house or funding your children's marriage—according to rules specified by the EPFO. On retirement, you can withdraw the entire corpus from both the accounts. On withdrawal, subscribers can choose to withdraw from either of the accounts. On retirement, they can also choose to extend both accounts by 3 years, which will help if the markets are not too favourable. For you, this means that finally you will be able to realise the benefits from EPFO getting to invest in equity. However, this may not be the best thing for certain segments of the workforce, cautions. People in the lower-income group may not be able to afford the volatility of the equity markets and therefore maybe at risk.
Patel is also of the view that this brings the EPF one step closer to getting merged with the National Pension System (NPS). EPF provides social security and therefore the design of the product was conservative. The NPS, on the other hand, is a long-term retirement product. But now with the EPFO also investing in equities, the goalpost seems to be shifting—from providing social security to being a long-term retirement product. It now begs the question, does the government need to review the position and purpose of the two products that achieve similar goals in the market
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