How salary cut impacts your PF corpus and gratuity4 min read . Updated: 17 Jun 2020, 11:14 AM IST
- Most of the retirement benefits such 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.
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.
In case of a salary cut, the various components of salary are revised on a proportionate basis.
“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.
If there is a 20% reduction in the salary, the basic pay plus dearness allowance will reduce to ₹16,000 and the PF contribution will come down to ₹3,840 per month.
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.
After completing five years of service, the organization has to pay an amount equalling 15 days of the last drawn salary for each year of service.
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.
“Companies looking at salary cuts need to look at alternative approaches to making the reduction across all components of pay against reducing the allowance part. The former approach with lower basic pay will have an impact on the quantum of PF contributions, gratuity and HRA, among others, and hence, may result in lower retirals and lower tax exemptions," said Saraswathi Kasturirangan, partner, Deloitte India.
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.
Also, as gratuity is dependent on the last drawn salary, there is hope for those who are working.
“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.