February 01 , 2013
Ever wondered why the credit in your Bank account every month seems so much lower than the CTC promised to you? If you are about to start earning, and have already begun dreaming about what you will do with the money, be prepared for a rude shock first! The salary passes through some compulsory filters before it gets to you. And in fact we will advise you to add a few more filters yourself if you are the profligate variety.
The first thing you should know is that the inevitable taxes get deducted from your salary by your employer - Professional Tax and Income Tax. Rs 2,500 in a year paid out as Professional Tax is inevitable. The Income Tax deducted depends on your annual salary, and can go as high as 30% if your income is Rs 10 lakh or higher. While you may not be able to avoid it altogether, you can avoid paying more than necessary by providing to your employer the following details at the beginning of the Financial Year:
- Specific investments that are eligible for tax saving
- Medical insurance you have taken or plan to take
- Rent that you pay
- Any home loan or educational loan that you are repaying
These taxes go permanently to the Government, so make sure you aren't paying more than necessary. Do independent calculations yourself, to verify that the tax deduction is appropriate. At the end of year, check if there is any shortfall or excess tax that has been paid, and file returns accordingly.
The second deduction that goes is the Provident Fund (PF). This equals 12.24% of your Basic Salary as your contribution, and another 12.24% from the employer's side. Of course, most employers count both contributions under the CTC. Now, unlike taxes, this is not really lost - it just goes towards building a long term fund for you. It gives you 8.3% annually, and is tax free as long as you keep it five years or longer. Best of all, if you shift jobs, this gets transferred to the new employer and continues getting built. Ideally, you should need these funds only at retirement.
Thirdly, some of the CTC components (like gratuity, LTA, bonus, etc) may be paid at the end of the year. Different organisations have different policies around this - many pay them in March, but some follow a calendar year. If you have joined in the middle of the year, the payout may be pro-rated to the months of the first year that you have been in service. This again, is merely postponing your income, and you aren't losing it.
That's it! The rest is for you to plan. We've seen people plan their budget in one of two ways, either of which work well if they are disciplined:
1. Balance their monthly expenses within monthly salary, but manage to save very little. Instead, they reserve bulk of the annual payouts for savings and investments.
2. Save ~30% of their monthly income, by running a tight ship. They then use the annual bonus to splurge -vacations, purchases, etc.
You can go by the plan that suits your style. But remember, the PF is grossly inadequate for your future goals and retirement. So you need to make sure about 25% or more of your annual income is saved, one way or the other!
If you are the kind who ends up spending anything that hits your bank account, work around that by devising direct debit savings options. One such way is to start a Systematic Investment Plan in a mutual fund. Let the amount get auto-debited from your Bank account as soon as salary hits, and well before you get a chance to splurge it. Keep this corpus building for a long time, ideally your entire career.