Anyone who has ever drawn a salary has, at one time or another, wondered why their take-home salary is so much lower than what they were told in their offer letter. Where has my money gone? It’s a familiar sinking feeling that employees everywhere have wrestled with, especially when they’re just starting out, or when they inevitably cross into the taxable bracket.
What at first seems like a mysterious void that your money is vanishing into soon reveals itself to be Tax Deducted at Source (TDS). Salary income is subject to income tax at various slabs depending on how much an employee earns annually. To truly understand what’s happening to your money, there are three fundamental things every employee should know. First: how their salary is structured. Second: which parts of their salary are taxable, and thirdly, how to make the most of the tax-deductible components.
What at first seems like a mysterious void that your money is vanishing into soon reveals itself to be Tax Deducted at Source (TDS)
Once these fundamental parts come together, the proposition becomes less mysterious and more graspable. Assuming a typical case in which there is no variable pay, a salary is structured into three components: Fixed Salary, Contributions, and Reimbursements. The Fixed Salary usually consists of Basic Salary, Dearness Allowance, House Rent Allowance (HRA), and a Special Allowance. Out of these, all except HRA are fully taxable. Contributions include those components a company invests for an employee’s long-term savings and social benefits, such as an Employee Provident Fund (EPF). The company and the employee make a minimum contribution of 12% of Basic Salary should an employee choose this option.
The third component, Reimbursements, is a component of a salary that is tax- deductible against certain expenses made and bills submitted. It includes benefits such as Fuel Reimbursement, Phone Reimbursement, Leave Travel Allowance, Books and Periodicals, and Meal Vouchers, to name just a few. If more employees opt for these reimbursements, they could walk away with more net salary every year. A survey commissioned to Nielsen India on employee tax benefits reveals that one in every four employees doesn’t understand this idea. A lot more employees (56%) opt out of reimbursements because they want more money in-hand every month. This happens because reimbursements are first deducted from a monthly salary before they’re added back in. The money is added back in an employee’s account after they submit bills of proof, and once these bills are verified. Before the benefit, there’s a small sacrifice of time. Because the money isn’t credited along with the monthly salary, there’s a sense of loss that employees perceive. Ironically, employees opt out thinking they’ll get more money every month, only to achieve the opposite result. They get a notional benefit in the present but end up forgoing a real money benefit in the future.
I call this the ‘In-Hand Salary Paradox’. The reason for this is a very human tendency to value instant gratification over having to ride out a future we perceive as uncertain. But, perceptions and realities are often different. Employees should be encouraged to think about the long-term: Make their calculations on annual pay over monthly pay. The perception can be changed through proper education and instilling the need for tax-planning in every individual from an early stage in their careers. This can be challenging, considering the complexity of income tax laws. This is compounded by a lot of misinformation that goes around the workplace as well.
Companies should make tax experts accessible to encourage employees to really understand their salary structures and enable them to sign up for reimbursements. As their salaries climb, there’s a potential annual saving of close to Rs 80,000 as a reward for this long-term thinking. The survey conducted on reimbursements also revealed that companies (an overwhelming majority of 92% of the ones surveyed) offer reimbursements to their employees because it helps with employee motivation.
There are, of course, other reasons why employees opt-out of reimbursements; even the ones that understand the value of the savings they can get. Around 62% of them claim the process is too time-consuming, and 41% need to submit a form for every single bill that they claim for reimbursement. The challenge they face is that in most companies, the process is still manual and paper-based. Approvals take time, and there just isn’t enough transparency in the process. For these reasons, 90% of them prefer digital reimbursements.
No matter how reimbursements are delivered and managed, the fundamental idea behind them is to decrease taxable income, and help employees save more every year. This can start to happen more consistently across the board, once the ‘In-Hand Paradox’ is solved in the mind of the employee.
Story as appeared in Fortune India on June 7th 2018