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  • Category: Investments

    Does EPF give interest on compound interest plus principle amount?


    Wondering how EPF compound interest calculated? Interested in resolving this query? Find responses from our ISC experts regarding the exact method of calculating this compound interest on a monthly and annual basis.

    Usually compound interest calculated includes previous principle amount. Right now EPF pays interest monthly, as such in EPF passbook show interest credited at end of month.
    But question is does EPF give interest on compound interest plus principle amount? Means do they include the previous year principle amount plus interest while calculating next year interest? or they simply use the principle amount without interest when calculating next year interest?
    Also is it also followed for calculating monthly interest that not to use previous month interest component for next month compound interest?
  • Answers

    2 Answers found.
  • Yes. The EPF interest is compound interest only. The interest obtained in a year will be added to your contribution. Then the total contribution you have made till that year and the interest obtained until the previous will be shown as the original amount and interest will be calculated on the total amount. The interest obtained last year will become a part of the principle this year. The total amount is taxfree.

    For example, if X is the original amount this year and the interest obtained is Y and the total will be X+Y.
    For the next year, your original amount will be X +Y and say interest obtained is Z. The total amount will be X+Y+Z. It will become the original amount for the next year.

    drrao
    always confident

  • Before understanding the compound interest, I will like to cover the simple interest a bit. If you have deposited Rs 1 lakh in a scheme where every year you are given out the simple interest of 8% per annum then at the year end you will get Rs 8000 as interest. So take this money and use it. Next year you will again get Rs 8000 and so on till you continue keeping your principal amount there.

    Now coming to the compound interest. If the scheme is such that your interest is kept back and added to the principal then next year you get interest on the increased principal and so on. The examples are cumulative fixed deposits of banks, NSc of Post Office, PPF account etc.

    Interest is generally credited at yearly rests. But some banks, companies and other entities do it at monthly or quarterly or half yearly rests and due to this the effective rate of return slightly increases. To give you an idea if the rate of interest is 7% then for half yearly interest calculations it will effectively become about 7.2%, for quarterly rests it will become 7.4% and for monthly rests it will become 7.6%. This is not the exact value but I am giving it to understand the concept.

    In EPF every month you contribute and the employer also adds from his side. So every month the amount is increasing. So it becomes logical to apply interest on monthly rests. So the calculations will be done accordingly in the cumulative mode only. Please remember, in compounding, whenever you apply an interest to the principal amount a new principal amount emerges which becomes eligible for the next interest calculation.

    Those who are not aware of these financial things get easily confused between the monthly or quarterly or half yearly rests. I will like to explain it here for clarity. Let us take an example of deposit of Rs 1000000 for 9% interest on the monthly rest interest calculation mode. Then after one month the interest will be calculated as -
    Interest after one month will be = (1000000 x 9)/(100 x 12) which comes to Rs 7500.

    Now the principal for the next month becomes 1000000+7500 = Rs 1007500 and the interest for the next month will be = (1007500 x 9)/(100 x 12) which comes to about Rs 7556.

    So due to monthly rest mode the monthly interest will go on increasing slightly. Definitely this is beneficial to the investor.

    Knowledge is power.


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