How Salary Cut Impacts Your PF Corpus and Gratuity?

Retirement benefits such as EPF contribution and gratuity are calculated based on the basic salary and dearness allowance of the employee. Hence, a cut or change in the salary structure may have bigger impacts on similar benefits.

The spread of Covid19 has impacted the economy in multiple ways. A lot of businesses are facing financial losses due to lockdown and quarantine measures implemented to break the spread of the disease.

Because of this, a lot of companies are resorting on salary cuts for employees to cut down the losses. Pay cuts are causing a serious impact on financial budget and spending capabilities of individuals.

Employee Provident Fund and Gratuity are calculated purely based on the basic salary and some other salary components. So based on the salary cut, the monthly contribution to these benefits may vary.

In the case of a salary cut, the various salary components are revised on a certain proportion. In this article, we are discussing the various aspects of it and trying to figure out if there is any way out of this mess.

Most of the corporates and private sector companies follow cost-to-company (CTC) structure. So when a salary cut is implemented in a company, it is executed across the various salary heads in the organization. So the cut will impact on multiple benefits which are dependent on the basic salary structure.

Effects of Salary Cut on PF Corpus

As per the EPF Act 1952, employees need to contribute 12% of the basic wage of the employee and DA amount towards the PF corpus. The employer also makes a matching contribution of 12% as the same as the employee.

If a person has a ‘basic salary + DA’ of INR 20,000, his monthly contribution towards Employee Provident Fund  would be INR 2,400 monthly and INR 28,800 per year.

The employer also contributes the same amount towards his/her PF and hence the combined monthly contribution towards his account would be INR 4,800.

So if there is a salary deduction of 20% as the cut, the ‘Basic + DA’ component will reduce to INR 16,000 and hence the combined PF contribution would become INR 3840 per month instead of INR 4800.

The lower contribution scale will impact the maturity corpus of the employee. The current rate of interest on EPF corpus is 8.5%. If we consider the same example for a person who has 20 years of service period remaining, his maturity corpus will reduce by 6 lakh Rupees.

How Gratuity is Affected by Salary Variations?

The gratuity amount depends on the years of service and the last drawn salary of the employee. It is the function of the basic salary and dearness allowance. If an employee’s basic salary has been affected by the salary reduction or cut, the gratuity will be impacted considerably.

The gratuity corpus is paid when a person retires or leaves the job after serving a minimum period of 5 years. The salary cut impact is going to affect mostly the employees who are nearing retirement or facing job loss due to the pandemic. By completing the minimum five years of the service, the organization is liable to pay the amount corresponding to 15 days of the last drawn salary for each year of service.

If we consider the case mentioned above, the ‘basic salary + DA’ of the employee is INR 20,000. If the employee completed 8 years of service in the current company, the gratuity amount will be equal to;

(15/26 x last drawn salary x years of service) = ₹92,307

If the salary cut of 20% is implemented, the gratuity amount will reduce to ₹73,846.

Is there a Solution?

The only way to work around this situation is to reduce the cut in the basic salary. If there is a chance, the employee should discuss the salary components with the employers and request to reduce the cut in the basic salary component.

Salary structure is not generally customized for each employee and it is uniform across all the members in the organization. Employers do have an option to tweak the salary structure by negotiating with the employer. Although it is not easy to do so.

Companies considering salary cut as an alternative to financial loss, should consider other ways to reduce various salary components other than basic pay. The current approach with lesser basic pay will impact the EPS corpus, Gratuity, HRA and other investments. The current salary cut, if not revoked will result in lower retiral sum and lesser tax exemptions.

The employees who are nearing the retirement age will be impacted by this situation the most because they might not get enough time to save more. Others have a few more years left to save more in the future and make up for the current reduction in savings amount.

Employees can contribute an additional amount to the Provident Fund if their budget allows them. This facility provided by the EPFO is termed as Voluntary Provident Fund (VPF). VPF offers similar returns and tax benefits as EPF.

The Gratuity amount is heavily dependent on the last drawn salary. So for those who are working right now, have more this way. Even if the employees are facing a pay cut right now, the situations might improve and the salary scales might go back up.

Since the Gratuity is something that affects the last drawn salary alone, employees who are not approaching the retirement age can consider this as an opportunity to accumulate more funds towards it.

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About Geet Sharma

My Name is Geet Sharma Financial Blogger & Founder of Paisabank.org. We are a personal finance blog dedicated to finance & financial planners. The main aim of this blog is to help people to informed about financial decisions.
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