Paying more than 40% of your take-home salary as loan EMI? New wage code to pinch you the most

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New Delhi: From April 2021, take-home salary of private sector employees is set to fall as companies need to restructure pay packages of employees as per the new wage rules. The government has notified the draft rules under the Code on Wages 2019. As per the new compensation rules, allowances can not be more than 50% of the total compensation. It means, that the basic pay (in government jobs, basic pay plus dearness allowance) will have to be 50% or more of total pay from April.

Typically, most of the companies keep the non-allowance part of employee's pay package at less than 50% to reduce their EPF and gratuity liability. But after the implementation of the new wage code, companies will have to increase the basic pay of employees to meet the new requirement. The revision will result in reduction in take-home pay as provident fund (PF) contribution of most of the employees will go up. Employees are required to contribute 12% of their basis pay to PF while employer’s contribution to EPF is either 10% or 12%.

"Tough the new wage code will reduce take-home salary of employees, their social security kitty as well as post-retirement gratuity amount will be bigger as gratuity is also calculated on the basis of basic pay, which will go up," said said Balwant Jain, chief editor of Apnapaisa.com. "However, the good thing is that your tax liability will also reduce as employers typically include their contribution to the employees' PF in their Cost-To-Company (CTC)," Jain added.

Despite the reduction in tax liability, the overall impact on take-home salary of employees will be negative and it will pinch the most to the employees in the lower income bracket as they are typically left with less surplus after providing for their monthly expenses and loan EMI if any. The situation will be more difficult for people servicing home loan along with a car loan or personal loan. For these people their EMI liability is generally more than 40% of their take-home salary. So even a 10% reduction in take-home salary will pinch them the most.

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To understand this let us consider an example. Suppose your gross salary is Rs 1 lakh at present and your basic salary is Rs 20,000. Your total PF contribution (including employer's contribution) is Rs 4,800. So your pre-tax take home salary comes to Rs 95,200 (assuming no other deduction is their). Once the new code becomes applicable your basic pay needs to be revised to Rs 50,000. So your monthly PF contribution (including employer's contribution) will increase to Rs 12,000, 150% higher than your existing contribution. Hence your pre-tax take-home salary will fall to Rs 88,000, nearly 8% less than your existing pre-tax take-home salary.

In the above example, suppose you are paying Rs 45,000 as EMI. Then after revision of your salary structure, you will be left will Rs 43,000 for your monthly expenses as against Rs 50,200 presently.

In such a case you have two options either to reduce your expenses or cut down on your monthly contribution to SIPs or PPF or NPS. It is obvious to get tempted to stop existing SIPs, which are for long term purpose. But as per investment experts, in such a case, one should not stop SIPs in equity funds as their portfolio will be debt heavy (24% of your income will be going to PF, which is a debt investment) rather they should reduce PPF or NPS contribution depending on their tax liability.