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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.
The second deduction that goes is the Provident Fund (PF). This equals ~12% of your Basic Salary as your contribution, and another 12% from the employers 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 8.5%-9.5% 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.
Improve your tax-home pay
As we saw earlier, there are four main factors that cause CTC to be different from take-home pay:
- Professional Tax
- Provident Fund
- Income Tax deducted at source
- Annualised payments like LTA, bonus and some allowances
Let's look at each of them in turn.
Professional tax is inevitable. Throughout your working career, you are going to be paying this to the Government.
If your monthly income is above Rs. 6,500, you can opt out of the Provident Fund. This would improve your take-home pay. However, we would strongly advise against this. First, your employer contributes to PF as much you do. So by opting out of this you lose that benefit. More importantly, the PF functions as a long term savings and retirement instrument. If you take this home, you would tend to spend this money away, leaving nothing for the long term.
This therefore only leaves income tax savings as the way to increase your take-home. We look at this in detail in the next chapter. You not only need to take action to save tax as given here, you also need to inform your HR immediately so that they take this into account and increase your take-home pay.
The annual components of your pay are not really deductions- you do get them at the end of the year. In many ways, this is a positive, since you tend to spend away anything that you earn every month. Whatever lump-sum you get at the end of the year is more likely to be a source of long-term saving.