If you are a salaried employee working in the private sector, there were two significant Supreme Court judgments passed in February and April this year that will have a considerable bearing on your pension, and how much of the monthly salary you can take home.
Let’s break it down.
In its February 2019 judgement, the Supreme Court ruled that any allowance that is generally available to all employees (travel, food coupons, entertainment, special allowance etc.) within the cost-to-company (CTC) salary structure will be now counted as part of their basic wage while calculating their contribution to the Employees’ Provident Fund.
What does this mean for your take home salary?
At a fundamental level, the employee’s contribution to the EPF amounts to 12% of his/her basic salary plus dearness allowance (cost of living adjustment to allowance). Typically, the employer matches that contribution.
However, the court ruled that employers cannot segregate ‘special allowance’ from basic wages because it believed “a part of the basic wage [was] camouflaged as part of an allowance to avoid deduction and contribution accordingly to the provident fund account of the employees.”
Having said that, certain categories of allowances are exempt under Section 2(b) of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, that include house rent allowance, overtime allowance, and performance-linked bonuses.
Where does that leave the employee?
Typically, a 12% cut to the EPF is compulsorily deducted when the basic salary is below Rs 15,000. This ‘basic salary’ is calculated as only ‘basic wage + DA’ and ignores all other allowances.
So you have to pay 12% of whatever your ‘basic wage + DA’ is, up to Rs 15,000.
Now, the other allowances will also be included in your basic salary when calculating how much you have to pay every month to your EPF. So in this case, your take-home salary will fall.
If your salary is above Rs 15,000, you have the option of opting out of EPF altogether (which is often unadvisable).
But in case you do decide to opt into EPF, your employer has two choices –
They can deduct 12% of Rs 15,000 – the mandated cut off amount, no matter how high the basic salary actually is.
Or they can choose to consider 12% of your entire basic salary – which now includes all your other allowances. This would increase your deduction (reducing take-home) and their contribution amount at the same time (increasing CTC).
This second choice has many repercussions. As the company’s contribution to the EPF will also go up, this means a rise in your CTC. So your employer may lower your subsequent salary hikes, or even reduce your salary to maintain the old CTC amount. But it would mean a dramatic rise in your PF amount.
Your employer can choose either.
Before discussing your pension, it’s essential to understand that of the 12% that your employer contributes to your EPF, 8.33% goes towards paying your Employees Pension Scheme (EPS).
“The scheme gives pension based on the number of years put in by the employee and his last drawn salary. Monthly pension = Number of years multiplied by last drawn salary divided by 70,” says this Economic Times explainer.
However, the general complaint among employees has been that the pension they receive from the EPFO is very low because it capped the ‘salary’ used to measure the amount at Rs 15,000 per month.
“It also capped the contribution to the EPS. Instead of 8.33% of the employer’s contribution, it was Rs 15,000 per year. After the recent SC judgement in April, employees covered by EPF will now be eligible for pension as per their full last drawn salaries,” the ET explainer goes onto add.
Essentially, the earlier verdict by the Kerala High Court said two things:
-Scrap the Rs 15,000 per month cap.
-The average pensionable salary will be calculated not based on basic salary+DA for the last 60 months, but for the previous 12 months before retirement.
“No scheme that defeats the purpose of enactment by reducing the pension payable to the employees in their old age to a ridiculously low amount, which is not sufficient even for ensuring a decent life to them, can be sustained,” observed the October 2018 Kerala High Court order.
On April 1, the Supreme Court of India upheld the Kerala High Court verdict.
However, where will the EPFO get the money to pay out these pensions?
“A simple explanation lies in the fact that money will be moved from the employee’s EPF account to their EPS account, to ensure that EPFO has enough money to keep paying out pensions in the years to come. Hence, the EPF that the employee will get on retirement will come down,” says this explainer by Vivek Kaul, the author of the ‘Easy Money’ trilogy, in a column for Bangalore Mirror.
In short, thanks to the court’s rulings, your take-home salary may come down, and your final PF payout may come down, but the pension you’ll receive could very well increase dramatically.
(Edited by Vinayak Hegde & Gayatri Mishra)