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How Salary Cut Impacts Your PF Corpus and Gratuity

17-Jun-2020

Many businesses are finding it tough to sustain amid the sharp revenues losses due to the lockdown implemented to prevent the spread of covid-19. Many of them have resorted to salary cuts in order to cut down on the losses. Pay cuts have a direct impact on the take-home salaries of the people and thus impact their financial budget as well as spending capacities.

However, salary cuts can also have an impact on some of your retirement benefits.

Most of the retirement benefits such provident fund (PF) contribution and gratuity are calculated on the basis of basic salary and dearness allowance. Therefore, a cut in salary will have an impact on these benefits. Let’s understand if there is a way out.

“Most of the organizations in the private sector have a salary structure based on the cost-to-company (CTC) structure. Therefore, most of the time it is seen that in case of a salary cut, the proportionate cut is implemented across the various heads of the salary," said Rituparna Chakraborty, co-founder and executive vice-president, TeamLease Services.

Therefore, the cut will have an impact on some of the benefits, which are based on the basic salary.

As per the Employees’ Provident Fund and Miscellaneous Provisions Act, employees have to contribute 12% of their basic wage plus dearness allowance towards PF. A matching contribution of 12% is made by the employer. Suppose a person has a basic salary plus dearness allowance of 20,000, then his monthly contribution towards PF will be 2,400 and with an employer’s contribution, it will add to 4,800.

A lower PF contribution will impact the retirement corpus of the person.

If a person has 20 years of service remaining, then as per the above example, the retirement corpus will reduce by 6 lakh, assuming a rate of interest of 8.5% on PF.

Similarly, another benefit that is likely to get impacted is gratuity. “The gratuity is a function of the basic salary and dearness allowance. If your basic salary has been affected by salary cut, then your gratuity will be impacted," said Adhil Shetty, CEO of Bankbazaar.

As gratuity is paid when a person retires or leaves a job after serving for at least five years, it is more likely to impact those who are nearing retirement or planning to leave the job or facing a job loss in the near future.

For example, if the basic plus dearness allowance was 20,000 and the person has completed eight years of service, the gratuity will be equal to (15/26 x last drawn salary x years of service) 92,307. If there is a salary cut of 20%, then it will go down to 73,846.

Is there a way out?

If there is a possibility then employees can discuss the salary structure with their employers to lower the cut in basic salary.

“It is generally not customized for each employee and is implemented in a similar manner across the organization. However, having said that employers do have the option to tweak the salary structure and an employee can negotiate it with the employer," said Chakraborty.

However, those who are nearing retirement will be impacted the most as they may not have enough time to save more.

While those who still have a few years left can save more in the future to make up for the lower savings.

Employees have the option to contribute more towards PF through voluntary provident fund (VPF). If their budget allows they can invest more towards VPF to make up for the loss of lower PF contribution. VPF enjoys the same returns and tax benefits as EPF.

“Gratuity is calculated using the last-drawn salary. So, even if you are facing a pay cut now, over time, when the situation improves and your salary goes up again, the gratuity you are eligible for will go up again," said Shetty.

Source : Live Mint

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