Saving money is a fundamental aspect of financial planning. While traditional savings accounts are joint, salary saving schemes offer unique advantages that can significantly enhance financial security. Please stay with Aseemoon.
In this article, we’ll explore the top 5 benefits of salary-saving schemes, why they are essential for both employees and employers and how some popular salary-saving schemes work in 2024:
What is a Salary Saving Scheme?
Basically, a salary saving scheme is a financial program where an employer deducts a portion of the staff’s salary for automatic deposit to a savings or investment account. Structurally, this way of saving assists employees in gradually building funds over some time without them having to manage it.
These schemes were introduced to ease the process of saving among workers, thus encouraging a financial cushion in the future.
Definition and Historical Background of Salary Saving Scheme
The concept of salary saving schemes has undergone several changes over the years. From an idea initially remodeled to infuse the habit of saving amongst employees, it turned out to be something more elaborate and profitable.
In its earlier and more primitive forms, it essentially was a simple savings account with low interest rates. However, with the development of financial markets and an increasingly realized perception that the future lies in careful and long-term financial planning, salary-saving schemes evolved into employer contributions, tax advantages, and higher interest rates.
Why Salary Saving Schemes are Important?
Salary saving schemes are essential tools that can provide financial security and stability to every individual’s life.
Schemes have quite a number of benefits that make them very important and thus indispensable in personal financial planning through the various financial mechanisms available, like retirement plans and savings accounts.
Financial Security and Stability
Salary saving schemes are of great importance in building financial security since they enforce the habit of saving part of an individual’s income at periodic intervals.
This disciplined investment avenue makes funds available in times of emergencies and significant expenses as well as retirement, hence safeguarding these individuals from financial hardships during unforeseen circumstances.
Retirement Planning
One of the significant reasons salary saving schemes are important is for retirement planning purposes. These plans, in the form of employer-sponsored 401(k) plans and individual retirement accounts, certainly help individuals save money throughout their working years.
Employees can garner a good nest egg to support old age through this if they contribute diligently, exploit employer matching, and take advantage of the tax incentives available.
Tax Benefits
Most salary-saving schemes have substantial tax benefits. Most retirement plans are tax-deductible, and this implies a reduction in the contributor’s taxable income in the contribution year.
In addition, earnings within the accounts usually grow either tax-deferred or tax-free, depending on the type of account. This added tax efficiency facilitates the growth of the savings over time.
Financial Discipline and Goal Achievement
Participating in salary saving schemes inculcates financial discipline through the automation of savings by way of habituated regular contributions.
This disciplined approach helps one remain focused on their financial goals, be it saving for a home, funding education, or other such milestones reached in life.
Reduced Stress Levels
It can thus be expected that a tremendous amount of financial stress negatively affects overall well-being. Salary saving schemes help reduce stress and improve quality of life since workers have a reliable avenue to save.
Popular Types of Salary Saving Schemes
Employee Provident Fund (EPF)
EPF is an abbreviation for Employees’ Provident Fund, which is a savings scheme designed to ensure the assurance of employees in regard to issues of financial need after the age of retirement. A provident fund account is maintained, and a given percentage is deducted every month from the employee’s salary.
The amount in this account is subject to some accumulated interest and, at the point of exit, can be withdrawn. EPF also comes with benefits that include a pension plan and life insurance cover, making it one of the most valuable tools for long-term financial planning as well as social security for an employee in most sectors.
The Employees’ Provident Fund (EPF) is a key retirement savings scheme in India. Here are the main points about EPF:
Purpose: EPF is designed to provide financial security to salaried employees after retirement.
Administration: It is administered by the Employees’ Provident Fund Organisation (EPFO) under the Ministry of Labour and Employment.
Eligibility:
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- Mandatory for employees earning up to Rs. 15,000 per month in organizations with 20+ employees
- Optional for others
Contributions:
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- An employee contributes 12% of basic salary + dearness allowance
- Employer matches with a 12% contribution
Interest Rate:
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- For 2023-24: 8.15% per annum
- Interest is tax-free
Tax Benefits:
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- Employee contributions are eligible for tax deduction under Section 80C
- Employer contributions are not taxable as perquisite
Withdrawal Rules:
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- Complete withdrawal allowed on retirement after 58 years of age
- Partial withdrawals are permitted for specific reasons like housing, education, etc.
Universal Account Number (UAN):
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- The 12-digit number assigned to each member
- Remains constant across job changes
Online Services:
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- Balance checks, withdrawal claims, and other services are available online
Additional Benefits:
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- Pension scheme (EPS) and insurance scheme (EDLI) linked to EPF
EPF serves as a crucial social security net for the Indian workforce, providing retirement benefits and financial security to millions of employees.
Public Provident Fund (PPF)
The Public Provident Fund is a scheme for long-term savings, backed by the Government of India, aimed at making people save specifically for their retirement; consequently, it has tax benefits. All Indian citizens may open this account.
However, there exists a minimum and maximum amount to be deposited every year. However, the funds have remained blocked for 15 years. The government decides a fixed interest on the investment; within a specified tenure, the entire interest is tax-free.
This scheme is trendy and safe for investment options, offering guaranteed returns under Section 80C of the Income Tax Act. The back of the government is not found in other investment options.
Here are the key points about the Public Provident Fund (PPF) scheme in India:
Purpose: PPF is a long-term savings scheme designed to provide financial security after retirement.
Eligibility: Open to all Indian residents. NRIs are not allowed to open new PPF accounts.
Account opening: Can be opened at post offices, nationalized banks, and select private banks.
Interest rate: Currently 7.1% per annum (as of 2024), compounded annually. The interest rate is set by the government quarterly.
Contributions:
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- Minimum: Rs. 500 per year
- Maximum: Rs. 1,50,000 per year
Duration: 15 years, extendable in blocks of 5 years after maturity.
Tax benefits:
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- Contributions eligible for tax deduction under Section 80C of the Income Tax Act
- Interest earned and maturity amount are tax-free
Withdrawals:
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- Partial withdrawal is allowed from 7th year onwards
- The complete withdrawal is permitted only after 15 years
Loan facility: Available from 3rd year to 6th year of account opening
Nomination: Facility available to nominate one or more persons
Risk: Low-risk investment as it’s backed by the Government of India
Other features:
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- The account can be opened in the minor’s name
- Only one account per person is allowed
- Balance not subject to attachment under court order
PPF is famous for its combination of safety, tax benefits, and reasonable returns, making it an attractive option for long-term savings and retirement planning.
National Pension System (NPS)
The National Pension System (NPS) is a voluntary retirement savings scheme. This Salary Saving Scheme is a government-sponsored social security plan designed to provide financial security and a regular income during retirement.
Implemented initially for government employees, the NPS has now opened a subscription to all citizens in order to contribute toward a pension account during their working life. With the participant contributing regular sums of money to this account, the same funds are then invested in various asset classes.
Partial withdrawal of the savings at retirement as a lump sum and for the remaining provision of a regular pension is made. NPS is known for tax benefits and its fair return generation capabilities; thus, it’s pretty attractive for long-term retirement planning. Here are the key features and advantages of NPS:
Eligibility:
- Open to all Indian citizens between 18-70 years of age
- Available for both government and private sector employees, as well as self-employed individuals
Account Structure:
- Based on a unique Permanent Retirement Account Number (PRAN)
- Portable across jobs and locations
Investment Options:
- Offers flexibility to choose investment patterns and fund managers
- Allows investment in equity, corporate bonds, government securities, and alternative assets
Contributions:
- Minimum annual contribution of Rs. 1,000
- No upper limit on contributions
Tax Benefits:
- Additional tax deduction of up to Rs. 50,000 under Section 80CCD(1B)
- Employer contributions are eligible for tax deduction under Section 80CCD(2)
- 40% of the corpus is tax-free at maturity
Withdrawal Rules:
- Partial withdrawal is allowed after three years for specific reasons
- At retirement, 60% can be withdrawn as a lump sum (40% of which is tax-free)
- The remaining 40% must be used to purchase an annuity
Low Cost:
- One of the lowest-cost pension schemes globally
Regulated:
- Overseen by the Pension Fund Regulatory and Development Authority (PFRDA)
Returns:
- Typically offers annual returns between 9-12% based on market conditions
Flexibility:
- Option to change investment allocation and fund managers
NPS is designed to help build a retirement corpus through regular savings and investments, offering tax benefits and potentially higher returns compared to traditional pension schemes.
Recurring Deposit (RD)
A Recurring Deposit (RD) is like a fixed deposit offered by banks and financial institutions, which allows investors to invest a fixed amount of money at fixed intervals monthly over a fixed period. It’s excellent for individuals who want to teach the habit of saving some money out of their periodic income flows and, importantly, aspire to an attractive interest income from their deposits.
The tenure of an RD can be between 6 months up to 10 years, and the installments and the interest on the deposit vary from one bank to another, but the rate of interest remains constant through the period of deposit. Finally, at the end of the maturity period, the accumulated amount is given back to the depositor along with the interest earned. Being a low-risk investment, it makes for valuable investments for conservative investors.
Here are the key points about Recurring Deposits (RDs):
Definition: An RD is a savings scheme where you deposit a fixed amount monthly for a predetermined period.
Features:
- Minimum deposit amount can be as low as Rs. 100-500 per month
- Flexible tenures, typically from 6 months to 10 years
- Interest rates are similar to fixed deposits, compounded quarterly
- No maximum limit on deposits
Benefits:
- Encourages regular savings habit
- Higher interest rates than savings accounts
- Suitable for short-term financial goals
- A low minimum deposit makes it accessible for all income levels
- It can be linked to a savings account for easy transfers
Flexibility:
- Some banks offer no penalty for missed payments
- Option to make bulk payments to cover missed installments
Interest and taxation:
- Interest is taxable
- TDS is applicable if interest exceeds Rs. 40,000 per year (Rs. 50,000 for senior citizens)
Additional features:
- Loan facility available against RD balance (up to 80-90%)
- Premature withdrawal is allowed, usually with some interest penalty
- Auto-renewal options available
Ideal for:
- Salaried individuals
- Those with regular income looking for disciplined savings
- Short to medium-term financial goals (e.g., vacation, education expenses)
Online facilities:
- Many banks offer online RD account opening and management
RDs provide a low-risk, disciplined approach to savings, making them popular among various income groups for achieving short to medium-term financial goals.
Comparison of Salary Saving Schemes
This table provides a comparison of the main features and tax benefits of each savings scheme:
| Scheme | Type | Interest Rate (2024-25) | Key Features | Tax Benefits |
|---|---|---|---|---|
| Employee Provident Fund (EPF) | Mandatory for salaried employees | 8.15% per annum | Employees and employers contribute 12% each of the basic salary | Tax benefits under Section 80C |
| Public Provident Fund (PPF) | Voluntary long-term savings scheme | 7.1% per annum | 15-year lock-in period; Tax-free returns | Tax-free returns; benefits under 80C |
| National Pension System (NPS) | Voluntary retirement savings scheme | Varies (depends on investments) | Flexible investment options; Pension on maturity | Tax benefits under Section 80C, 80CCD(1B) |
| Recurring Deposit (RD) | Fixed monthly savings for a set period | 5-7% per annum | No tax benefits | None |
How Interest Rates Work in Salary Saving Schemes
Salary saving schemes provide higher interest rates compared to regular savings accounts. This is so because these schemes collect money from different people and then get them invested in value-diversified portfolios comprising mostly higher-yielding assets such as stocks, bonds, and other security instruments.
Fund managers, therefore, benefit by pooling funds and consequently achieving economies of scale necessary for accessing these types of investments that may not be accessible to individual investors.
An attractive feature of salary saving schemes is the higher rates of interest aimed at generating better returns in the long run, which would be very useful to those who save for retirement or other long-term financial goals.
Whereas these schemes do come with some element of risk, the possibility of greater returns is usually the main attraction that draws in participants seeking better returns on their savings compared to ordinary savings accounts.
Tax advantages and incentives are, therefore, some of the main attractions for salary-saving schemes. They have various benefits for participants, thereby giving them better control over their general financial planning and saving strategies. The following details the overview of the tax benefits that generally characterize these schemes:
Comparison with Regular Savings Accounts
While regular savings accounts offer liquidity, salary saving schemes provide better growth potential.
Standard Savings Accounts
Standard savings accounts typically offer lower interest rates, making them less effective for long-term wealth accumulation.
Salary Saving Scheme Accounts
Salary saving scheme accounts, with their higher interest rates and additional employer contributions, offer superior growth potential.
Tax Advantages and Incentives
One of the significant benefits of salary saving schemes is the tax advantages they offer. These tax benefits and incentives, in turn, are a big attraction for salary saving schemes, enabling the participants at large to derive several advantages in terms of better overall financial planning and savings strategies. Following is the overview of the tax advantages usually offered by such schemes:
Tax-Deferred Contributions: Most salary-savings schemes allow account holders to make pre-tax contributions. In essence, it means that the contribution is deducted from the taxable income of the individual in the year he contributes. It thus reduces the overall amount of tax payable by lowering one’s taxable income.
Tax-Deferred Growth: Apart from the more obvious tax-deferred contributions, most of the earnings within salary saving schemes are tax-deferred. This means that participants are not required to pay taxes on the investment gains, dividends, or interest earned within their accounts until they make withdrawals during retirement.
Tax-Free Withdrawals (in some cases): Provided certain conditions are met, different retirement-oriented salary-saving schemes can indeed allow tax-free withdrawals. It simply means that under specified conditions—like attaining the age factor and maybe holding the account for a minimum time—one could withdraw the contribution and earnings tax-free.
Employer Matching Contributions: Most of the employer-sponsored salary-saving schemes, such as 401(k) plans, have an employer-matching contribution. It actually means that it is free money from the employer based upon the level the employee contributes. Usually, employer contributions like this are tax-deductible for the employer and not counted toward the employee’s taxable income until withdrawal.
Tax Credits: Sometimes, governments provide tax credits or incentives rather than offering personal contributions to retirement savings schemes. These may have the direct effect of reducing a part of the tax due, giving the individual extra benefit for providing for the future.
Exemptions from Capital Gains Tax: These may apply to participants, depending on the jurisdiction and the type of investments held within a salary-savings scheme. It could further enhance the overall after-tax returns on investments held within the scheme.