Learn How Pay Cuts Can Impact Your PF Corpus and Gratuity

Most employee retirement benefits like gratuity and PF contribution get calculated as per the basic pay and DA or dearness allowance of the employee. Therefore, a salary cut will directly reduce the sum deposited in these retirement benefits.

The COVID-19 pandemic and the resulting lockdown has impacted many businesses. Major businesses across sectors are experiencing sharp losses in their revenues. Owing to the complete disruption of business, many organisations are forced to resort to pay cuts to cushion the heavy losses.

For an employee, these salary cuts directly impact their take-home pay, which in turn impacts their spending capacity and their monthly financial budget. As a result, many concerns may have arisen in your mind—how salary cuts impact gratuity or how salary cuts impact PF and gratuity.

Yes, it is a fact that a cut in salary will have some impact on the retirement benefits. So, let us check out how salary cuts impact PF and gratuity and what you can do about it.

Salary structure

Before we understand how your benefits get impacted by a pay cut, let us first learn about a salary structure. Most employee retirement benefits like gratuity and PF contribution get calculated as per the basic pay and DA or dearness allowance of the employee. Therefore, a salary cut will directly reduce the sum deposited in these retirement benefits.

If an employer resorts to pay cuts, then different components of the salary get revised proportionally by the employer.

The salary structure of most private sector organisations employs the CTC or cost-to-company structure model. Therefore, in the event of a cut in salary of the employee, the cut gets implemented proportionally across different salary heads, like basic salary, dearness allowance, risk allowance, travel allowance, etc.

Now, as this proportionate cut gets implemented on the basic pay and DA or dearness allowance as well, it will have a certain effect on all the benefits that are linked to the basic pay and DA or dearness allowance.

How salary cuts impact PF

If an employer decides to cut the salary of employees, there is bound to be an impact of the salary cut on PF. Let us see how.

According to the Employees’ Provident Fund and Miscellaneous Provisions Act, an employee contributes 12% of the basic pay and DA or dearness allowance towards their employee provident fund or EPF account. Plus, the employer also makes an equal contribution of 12% towards the employee’s EPF account.

Now, let us suppose the basic pay + dearness allowance of the individual is ₹30,000, then the monthly PF contribution will be ₹3600 each from the individual and the employer. Therefore, the total PF cut on salary stands at ₹7200.

If the employee’s salary is cut by 20%, then the resultant basic salary + dearness allowance would reduce to ₹24,000. Therefore, the resultant cumulative monthly PF contribution in the employee’s EPF account will go down to ₹5760.

This low PF contribution would also impact the final retirement amount of the employee.

Now, let us assume the employee has a remaining service period of 20 years. Assume that the employee will get an annual salary hike of 5% every year for the remainder of the 20-year period. Then, going by the above PF calculation, the retirement amount of the employee will get reduced by approximately ₹8 lakhs.

How salary cut impacts gratuity

Likewise, a cut in salary also impacts the gratuity amount. Essentially, gratuity is the sum function of basic salary + dearness allowance. Therefore, if the basic pay and DA or dearness allowance of the employee is affected by a cut in salary, then their gratuity amount will also get impacted.

Since gratuity is generally paid to the employee at the time of retirement or when they leave the job after a particular period, the reduction in gratuity amount will mostly impact those nearing their retirement or looking at a future job loss or planning to quit.

Generally, the employee is eligible to receive gratuity after completing a minimum of 5 years of continuous service with the employer. The company is liable to pay half a month’s salary for every year of service, depending on the last drawn salary.

For example, let us assume that the basic pay + dearness allowance of the employee is ₹30,000. And that the employee has completed 7 years of continuous service with the employer.

Then, the gratuity cut from salary is calculated as n*b*15/26.

Wherein, n = number of years of service completed with the employer, 

b = dearness allowance + last drawn basic salary.

Therefore, the gratuity amount will be ₹1,21,154. 

If the cut in salary is 20%, then the gratuity amount will be ₹96,923.

Possible solutions

If possible, the employees can talk to their employers about their salary structure and ask them to lessen the cut from the basic pay.

Generally, the salary structure is common across the company, and it cannot be customised as per individual preferences. However, some employers still provide the option of tweaking or making slight changes to the salary structure, and the employee can try to negotiate the structure with their employer.

Companies should also look at other models of pay cuts rather than reducing all parts of the salary. After all, the former method will impact the PF and gratuity payout the most.

It is observed that those employees who are near their retirement period will get affected the most by the pay cut, as they do not have ample time to plan for more savings. However, those employees who have some years to go could plan to save more to cover up the low PF and gratuity savings.

Employees can plan to increase their PF contribution via the Voluntary Provident Fund (VPF) to cover up for any loss induced due to low PF contribution if their monthly budget allows them to do so. An individual can avail the same tax benefits and returns with VPF as with EPF.

Moreover, the gratuity is calculated as per the last drawn salary of the employee. Therefore, even if there is a salary cut now but the situation eventually changes and the salary increases, the gratuity sum will also increase again, resulting in more than expected payouts at the time of retirement.

This is how a cut in salary will impact the PF and gratuity of an employee. Employees planning on retirement will face the most impact of this salary cut. Young employees or those who still have ample time for retirement can maximise their savings to cover up for the loss in PF contribution and gratuity.

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Subin
Subin

One of the prime contributors for this blog. I have 5 years of experience in SEO, Digital Marketing, Content Marketing, and have knowledge in topics like Tax, HR, Recruitment & Staffing. A free-spirit with a passion for travelling & music.

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