Financial Literacy for the 20-something: Part 1 — The Payslip
21-year-olds can be reckless, especially when they’ve just received their first paycheck and the city looks like it’s suddenly come alive with the possibility of booze, dates, and eating minuscule hors d’oeuvres from pretentious resto-bars. This can wreck your finances and self-image in your 30’s when you really start building your life. Your road to salvation though isn’t too long and starts with a basic understanding of why you earn what you earn. So just download your payslip if you haven’t already and follow along.
Now, this might seem something you need a tax consultant for, but understanding your payslip is the smallest of prices to pay for financial independence. So let’s simplify this with a few terms and some basic math.
CTC (Cost to company): This is essentially what the company pays to employ your services. Most young employees mistake this for what they earn. Confused? Okay, consider this equation:
CTC = Fixed pay + Variable Pay + Employee Stock Options (ESOPs) + Joining/Retention bonuses
Fixed pay is what the company is going to pay you regardless of how you perform every month. This is your bread, butter, and air. Nobody can take this away from you.
Variable pay is what they might give you as an incentive for your performance and the company’s performance that year or quarter.
ESOPs are company stocks you’re offered to sell your soul to your employer so you can push that share price up a few cents.
Joining or Retention bonus is money that you have to return to your employer if you leave before a certain time period, usually a year from joining. This bonus is a one-time affair that will never grace your payslips for the rest of your life in that company.
As a result of variable pay and ESOPs, your CTC tends to be a pumped-up number. I know many educated idiots that throw an INR 65 lacs CTC at me while their ESOPs which haven’t even been listed on a stock exchange account for INR 20 lacs and their variable is a whopping INR 15 lacs.
To simplify planning, I want you to say, “I only earn my fixed component” a hundred times every day for 30 days. We don’t give a shit about any component that you’re NOT GUARANTEED. Unless you’re absolutely killing it at work or your company is exceeding its annual target, every number on your payslip is likely to only denote your fixed component.
Now, I want you to pull up your payslip and take a good look at it. It should look something like this:
You have two clear and self-explanatory sections — Earnings and Deductions
Your Earnings section is essentially your monthly CTC split into multiple confusingly named components. In the case above, we only have the fixed component of the CTC in the earnings section. Some of the components are tax-exempt while some are not. So let’s dive a little deeper.
Basic Pay: Not to be confused with Fixed Pay or Fixed Salary. This component is the minimum amount of money that the government mandates that your company has to pay you before other allowances are piled on. This is also the component on which your PF deduction is calculated. We’ll talk about that a little later.
House Rent Allowance: This is a component that your company gives you so you don’t have to pay tax on it as long as you provide the rent receipts to them. Obviously, most people don’t max out on the HRA because, a. You just might not need a palatial house and b. Paying out more for tax benefits is like shelling out INR 100 so you don’t have to pay INR 30 to the government. Just plain stupid. But I know many uncles who’ll push you to take a housing loan just for the tax benefit.
Special Allowance/Flexible Benefits Allowance/Differential Allowance: There is literally nothing special or additional or flexible about this one. They just had to give it a name to set it apart from basic pay so they don’t have to pay PF on that amount.
Leave Travel Allowance (LTA): This is another tax-exempt component of your salary if you choose to claim it. Essentially, if you’re traveling during that financial year for personal reasons and you provide the flight and hotel bills to the company, you can avail of tax benefits to that amount at the end of the year.
Sodexo/Meal Allowance: Just a tiny amount that you can avail as tax-exempt if you use a meal card in the company cafeteria.
While you may be tempted to max out your tax benefits by going ape-shit on allocating LTA, I want you to remember that in most cases the company withholds the amount that you allocate till the end of the year until they receive your receipts. This means that money lies around collecting no interest until you produce proof of travel. If you can’t justify traveling enough to cover the whole LTA, the differential suffers tax when it's paid out to you. There are better ways to invest that money.
Add up all of the above and that gives you your earnings.
Now comes the least fun part of your payslip — Deductions
Voluntary Provident Fund (VPF) and Provident Fund (PF): The government of India has mandated that 12% of your basic pay (Voluntary Provident Fund or Employee Contribution) should be saved against your will in the Employee Provident Fund scheme (EPF). The employer is forced to match with an equivalent contribution to that scheme (Provident Fund or Company Contribution). Companies pull off a dirty trick by showing their contribution towards the PF as part of your CTC. Hence, it shows up on your payslip even though you’re not the one paying towards that component. The amount of money you put in is completely left to you but your employer will only pay the same 12% of basic pay. The sum of VPF and PF is tax-exempt under Section 80C of the Income Tax Act. So, if you put in INR 5000 and your company puts in INR 5000 every month, you get a tax exemption of 30% on 10000 or INR 3000.
Professional Tax: I guess this is the cost of being a professional, whatever that means. It’s a meager INR 200. Don’t worry about it.
Income Tax: Now this one is a big chunk of your deductions and people find the calculation way too complicated but it becomes easy to understand if you just break it down and understand it. I’ll cover this in another post for the sake of keeping this one readable.
Now that you’ve understood your payslip (I hope you have or I’m a shit explainer), take a few minutes to compare payslips from different months and years to spot discrepancies and differences, and stay tuned for my next post!
