Receiving a promotion or an increment is always an exciting time. Almost immediately we begin planning the additional funds and gear up for a celebration. However, the celebration many times is short-lived as the money seen on paper may not reflect in the bank account. A common philosophy amongst the majority of salaried people is that they simply divide the Cost to Company (CTC) by 12 and expect that figure to reflect in their bank account at the end of the month. However, it is not that simple. Here are a few reasons why your paycheck may shrink even after you may receive a salary hike.
Taxes: Income tax is directly proportionate to the income earned in the year. To put it simply, the higher the income higher the tax. Therefore when you receive a hike, the tax deduction will be substantially higher than your last salary. For example, if tax deduction per month was Rs 2000 at 10 Lakhs per month CTC, it will rise at every additional income received after 10 Lakhs. In addition, the tax slabs in India are different at each income stage with a 30% tax rate above income of Rs 12.5 Lakhs per annum. To save money, it is pertinent to avail appropriate tax-planning measures.
Provident fund: This is a mandatory saving tool initiated by the government, wherein the employee and employer have to contribute each of their prescribed share to the provident fund authority. The rate of contribution is derived from the amount of the basic pay component. Therefore, when your salary increases, your basic pay also rises and thus giving rise to the mandatory contribution amount of the provident fund.
Now, when the company describes your salary package as CTC that includes the employer’s mandatory contribution as well. Therefore, it may seem like the CTC has increased, however, the deduction may make it look less.
Rise in expense: This is generally out of our control. A lot of factors lead to an increase in our monthly expenses. It might be moving cities for newer work opportunities, changes in house rent, the impact of inflation on the monthly budget, etc.
These are major factors that shrink your paycheck. However, there are ways in which you can keep your paycheck healthy. Here are some of them:
1. Tax planning is an essential factor in keeping your paycheck healthy. If you don’t plan your tax, you might as well end up paying more than the person earning more than you. The tax could be saved in two ways, one by either investing money or second by claiming an allowable expense. Some of the investment ideas for tax-planning are health insurance, public provident fund, ELSS mutual fund or National Pension Scheme. In case you are planning to buy a house for residential or investment purposes you can save tax up to Rs 3.5 Lakhs. Tax planning should be considered in consonance with your financial objective. Since you become aware of your pay raise in the first month of the financial year, you have time to plan your investments and save on tax.
2. Wealth is not created by an increase in the paycheck. It is created by increased savings and optimum investment. Therefore, as long as your savings are increasing as per your income, financial independence will be just around the corner. Increased savings or investment might hamper your in-hand salary, however, this does not mean you should be unhappy with your pay raise. Before switching jobs always understand how much more savings are you going to make instead of learning how much more are you going to earn.
Shrinking paycheck is common amongst millennials who constantly run after increasing their income. Although not a bad idea to increase your income, it is futile if it is not put to proper use. Financial independence can only occur if there is the successful execution of the plan and a healthy paycheck is of paramount importance for the same.
(Viral Bhatt is the Founder of Money Mantra — a personal finance solutions firm)
