Difference Between Provident Fund and Pension Fund

Provident fund is a fund created by the employer’s in which a certain percentage of the basic salary is contributed every month by the employer and the employee. On the other hand, the pension fund is a fund established by the employer in which a certain percentage of employee’s salary is contributed month on month by the employer.

At present, employees are regarded as assets of the company are they are responsible for its performance and position in the market. In fact, the success and failure of any company lie on the shoulders of its employees. For the purpose of retaining the efficient and hardworking employees for a long time, there are many allowances perquisites offered by the employer. One such scheme is to give them retirement and old age benefits so that they will not have to struggle at the later stage of life. Here we are talking about the provident fund and pension fund.

There are a number of differences between provident fund and pension fund which are described below in four category

  1. Comparison Chart
  2. Definition and it’s types
  3. Key Differences
  4. Conclusion

1. Comparison Chart

BASIS FOR COMPARISON PROVIDENT FUND PENSION FUND
Meaning A fund in which employer and employee makes a contribution while an employee is in employment with the organization is known as Provident Fund. A fund created by the employer in which he contributes an amount, for providing retirement benefits to the employee is known as Pension Fund.
Who is eligible to make a contribution? Both employer and employee Employer and Central Government
Statute Employee’s Provident Fund Scheme, 1952 Employee’s Pension Fund Scheme, 1995
Nature of amount received Lump sum Either in lump sum or in the form of regular income, depends on the pension opted by the member.
Basis of amount The contribution made by both the parties, plus interest thereon. The pension amount will the based on an average of last 12 month’s salary and years of service.
Withdrawal A person can withdraw the entire amount of provident fund. Only one third amount can be withdrawn.

2. Definition of Provident Fund (PF) and it’s types

Provident means to provide for future and fund refers to a sum of money kept aside for a particular purpose. Therefore, the term provident fund (PF) means keeping a certain sum of money aside to provide retirement benefits. In this scheme, a specified sum is subtracted from the employee’s salary and transferred towards the fund in the form of his contribution. The employer also participates in contributing money to the fund. The rate of contribution to PF is 12%.

The employee’s account is credited with the amount of interest received from investing the contribution of both the parties in approved securities. At the time of the employee’s retirement or resignation, the accumulated amount of the fund is paid to him. However, if the employee dies, the same is given to his legal representatives. The given are the types of Provident Fund:

  • Statutory Provident Fund (SPF): Statutory Provident Fund applies to the persons who are in employment with the government, university, etc., whether it is central, state or local self. The amount received is fully exempt from tax.
  • Recognized Provident Fund (RPF): This applies to the establishment which employs 20 or more persons. The Fund is recognized by the Commissioner of income tax. The amount received on maturity will be free from tax only if:
    • The employee served for more than five years.
    • The employee served for less than five years and the reason for termination is due to ill-health or employer’s business ceases to exist etc.
  • Unrecognized Provident Fund (URPF): Unrecognized Provident Fund is a fund started by the employer and employees of the organization, but not recognized by the Commissioner of Income Tax. Leaving employee’s contribution, the rest of the amount is taxable as income from salary.
  • Public Provident Fund (PPF): This is a provident fund scheme for the self-employed person, in which they can make a contribution of Rs 500 to Rs. 150000 per year. The amount received and contributed is fully exempt from tax.

Definition of Pension Fund

In simple terms, the word pension means regular payments made by the government or any other employers to their employees, for the services rendered by them in the past.Pension fund implies a fund in which the employer contributes an amount for providing the following benefits like superannuation (regular payment made into a fund by an employee towards a future pension) , retirement, disability and others.

The fund is financed by the transferring a part of employer’s contribution towards an employee’s provident fund to pension fund i.e. when the employer contributes 12% to provident fund, 3.67% is contributed to the provident fund and rest is diverted towards pension scheme. Central Government also contributes to the pension fund at a rate of 1.16% of the pay of the employee provided certain conditions are fulfilled.

On the retirement of the employee, he will get periodic payments of a specified sum such pension is known as uncommuted pension which. However, the employee can also opt for commuted pension whereby he can get the entire or part amount in a lump sum.

3. Key Differences Between Provident Fund and Pension Fund

The following are the major differences between provident fund and pension fund:

  1. Provident Fund is a kind of fund in which employer and employee make a contribution during the service of the employee to provide for future benefits. Pension Fund, on the other hand, is also a fund in which employer contributes a specified sum to provide retirement benefits to the employee as a consideration for his past services.
  2. In provident fund, both employer and employee contribute to the fund, but in the case of pension fund employer and central government contribute to the fund.
  3. Provident Fund works under the Employee Provident Fund Scheme, 1952 whereas Pension Fund works under Employees Pension Fund Scheme,  1995.
  4. The amount received by an employee in Provident Fund is in a lump sum. Conversely, it is up to the employee whether he wants to commute his pension or not in the case of the pension fund.
  5. In Provident fund, the amount received is an aggregate of the contribution made by both the parties and interest thereon. In contrast to the pension fund, the basis of pension is an average of 12 month’s last drawn salary and period of service

4. Conclusion

Provident Fund and Pension Fund are two schemes of government, in which an employee can get consideration for his services rendered by him for years. An employee can withdraw the whole or part of an amount in the provident fund when he is in need of it, like the construction of the house, illness, marriage or education, etc. However, the only one-third amount can be withdrawn in case of the pension fund.

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PF vs PPF: What’s the difference?

1. What is PPF and PF?

EPF/ PF

The Employee Provident Fund, or provident fund as it is normally referred to, is a retirement benefit scheme that is available to salaried employees.

Under this scheme, a stipulated amount (currently 12%) is deducted from the employee’s salary and contributed towards the fund. This amount is decided by the government.

The employer also contributes an equal amount to the fund.

However, an employee can contribute more than the stipulated amount if the scheme allows for it. So, let’s say the employee decides 15% must be deducted towards the EPF. In this case, the employer is not obligated to pay any contribution over and above the amount as stipulated, which is 12%.

PPF

The Public Provident Fund has been established by the central government. You can voluntarily decide to open one. You need not be a salaried individual, you could be a consultant, a freelancer or even working on a contract basis. You can also open this account if you are not earning. 

Any individual can open a PPF account in any nationalised bank or its branches that handle PPF accounts. You can also open it at the head post office or certain select post offices.

The minimum amount to be deposited in this account is Rs 500 per year. The maximum amount you can deposit every year is Rs 70,000.

2. What is the return on this investment?

EPF: 8.5% per annum

PPF: 8% per annum

3. How long is the money blocked?

EPF

The amount accumulated in the PF is paid at the time of retirement or resignation. Or, it can be transferred from one company to the other if one changes jobs.

In case of the death of the employee, the accumulated balance is paid to the legal heir.

PPF

The accumulated sum is repayable after 15 years.

The entire balance can be withdrawn on maturity, that is, after 15 years of the close of the financial year in which you opened the account.

It can be extended for a period of five years after that. During these five years, you earn the rate of interest and can also make fresh deposits

4. What is the tax impact?

EPF

The amount you invest is eligible for deduction under the Rs 1,00,000 limit of Section 80C.

If you have worked continuously for a period of five years, the withdrawal of PF is not taxed.

If you have not worked for at least five years, but the PF has been transferred to the new employer, then too it is not taxed.

The tenure of employment with the new employer is included in computing the total of five years.

If you withdraw it before completion of five years, it is taxed.

But if your employment is terminated due to ill-health, the PF withdrawal is not taxed.

PPF

The amount you invest is eligible for deduction under the Rs 1,00,000 limit of Section 80C.

On maturity, you pay absolutely no tax.

5. What if you need the money?

EPF

If you urgently need the money, you can take a loan on your PF.

You can also make a premature withdrawal on the condition that you are withdrawing the money for your daughter’s wedding (not son or not even yours) or you are buying a home.

To find out the details, you will have to talk to your employer and then get in touch with the EPF office (your employer will help you out with this).

PPF

You can take a loan on the PPF from the third year of opening your account to the sixth year. So, if the account is opened during the financial year 1997-98, the first loan can be taken during financial year 1999-2000 (the financial year is from April 1 to March 31).

The loan amount will be up to a maximum of 25% of the balance in your account at the end of the first financial year. In this case, it will be March 31, 1998.

You can make withdrawals during any one year from the sixth year. You are allowed to withdraw  50% of the balance at the end of the fourth year, preceding the year in which the amount is withdrawn or the end of the preceding year whichever is lower. 

For example, if the account was opened in 1993-94 and the first withdrawal was made during 1999-2000, the amount you can withdraw is limited to 50% of the balance as on March 31, 1996, or March 31, 1999, whichever is lower.

If the account extended beyond 15 years, partial withdrawal — up to 60% of the balance you have at the end of the 15 year period — is allowed.

In both cases, contributions get a deduction under Section 80C and the interest earned is tax free. 

Having said that, PF scores over PPF in two aspects.

In the case of PF, the employer also contributes to the fund. There is no such contribution in case of PPF.

The rate of interest on PF is also marginally higher (currently 8.65%) than interest on PPF (9.8%).

Differences Between a Cheque, Demand Draft (DD) and Pay order

A cheque is a Bill of Exchange drawn on a specified banker and not expressed to be payable otherwise than on demand.

Demand Draft is a pre-paid Negotiable Instrument, wherein the drawee bank acts as guarantor to make payment in full when the instrument is presented. DD cannot be dishonored as the amount is paid before hand. Demand draft is usually used to make payment outside a city. Demand Draft can be cleared at any branch of the same bank. A demand draft of value Rs 20,000 or more can be issued only with A/c payee crossing.

The payment order is a financial instrument issued by the bank on behalf of customer stating an order to pay a specified amount to a specified person within the same city.

Note: Cheque and Demand drafts (DD) are both negotiable instruments. Both are mechanisms used to make payments.

Example to differntiate the Cheque and DD

Let us say that you want to make payment for the purchase of a flat. On the day of registration, if you hand over a cheque and the property is registered and the cheque bounces for some reason, you cannot reverse a property that is registered.

In a demand draft there is guaranteed payment by the banker and there is no question of it bouncing. The biggest difference between a cheque and a DD is that the payment is always honoured.

Pay Order or Banker’s Cheque

The payment order is a financial instrument issued by the bank on behalf of customer stating an order to pay a specified amount to a specified person within the same city.

In payment order is pre-printed with the word “Not Negotiable” . There is no chance of dishonoring as the amount is prepaid. Once issued Pay order will be valid for 3 months.

Instruments  Pay Order  Demand Draft
Purpose Pay order is an instrument used to make payment within the same city DD is used to transfer money by an individual from one city to another person in a different city.
Feature Pay order are pre-printed with “NOT NEGOTIABLE”. Demand Draft is a negotiable instrument
Clearance Pay order to be cleared in any branch of the same city. DD can be cleared at any branch of the same bank.

Financial transaction tip: In a business transaction, cheque is not usually accepted as the drawer and payee are unknown and there will be credit risk. So, in such cases Demand draft is accepted where the transfer of money is guaranteed.