As variable part of salary rises, manage your cash flows better
4 min read . Updated: 30 Aug 2020, 10:37 PM ISTMake sure your non-discretionary expenses such as EMIs are taken care of by the fixed part of your pay
As companies struggle to survive and reduce costs amid the covid-19 crisis, a lot of them are changing the salary structures of employees by increasing the variable component linked to performance. This may result in cost savings for the companies, but may increase uncertainty in terms of cash flow for the employees.
According to the 2020 Workforce and Increment Trends survey conducted by Deloitte Touche Tohmatsu India, which took into account 350 companies across 25 sub-sectors, around 24% of the companies said they are planning to change their pay mix, tilting it more towards variable pay.
At present, the variable component accounts for around 15% of employees’ salaries across various levels but this percentage is likely to go up, said experts. “We expect this to gradually trend up to 20% of the pay," said Anandorup Ghose, partner, Deloitte India.
High variable component may make it difficult to manage cash flows as it could vary depending on the performance of the businesses and individual employees. “In some years, cash flows may take a hit if the company does not meet targets, whereas in other areas, employees may earn significantly more if the company performs better," said Ghose.
We tell you what you can do to organize your cash flows, expenses and investments.
Analyse Cash Flows
The first step is to estimate the amount of variable component you may get. “We have seen that people are able to reasonably predict the amount of variable they are likely to get depending on how much they have received in the past," said Vishal Dhawan, founder, Plan Ahead Wealth Advisors. For 2020 and 2021, people have conservative estimates, he added.
However, some planners consider only the fixed part of the salary when drawing up a financial plan. “This makes the overall plan more conservative, but the plan will hold good even if the variable part does not come in. When it does, it’s a positive outcome, which enhances overall wealth. But even if it does not come, we have planned for the worst," said Priya Sunder, director and co-founder, PeakAlpha Investments, a financial planning firm.
Generally, variable component is paid quarterly, half-yearly or annually. This means that this portion cannot be used for recurring deposits or investments such as systematic investment plans (SIPs) of mutual funds.
“Investors can park the variable component in a debt fund and opt for a systematic transfer plan to invest regularly," said Dhawan.
Sunder advises that this part be used for upfront expenses such as education costs, vacations or for reducing liabilities. “Otherwise, the money can be invested in line with the client’s asset allocation," she added.
Fixed Expenses First
When the variable component goes up, use your fixed pay to budget for your fixed expenses such as EMIs. “Ideally, the sum of all the non-discretionary expenses should not exceed the fixed portion of the salary. If the fixed component is not enough for all non-discretionary expenses, including EMIs, a relook at planning is needed," said Renu Maheshwari, CEO and principal advisor at Finzscholarz Wealth Managers LLP.
Ensure that you are not funding your discretionary expenses at the cost of non-discretionary ones. Check interest rates you are paying on your loans. If it’s higher than the market rate, get it reduced or transfer the loan balance to other bank. The last option is restructuring the loan if you are struggling to pay EMIs. “Connect with your lender to get the tenure increased to reduce the EMIs. Generally, we don’t recommend it, as an increase in tenure leads to a rise in the overall cost of the loan. But if you are finding it difficult to service the current EMIs, this can be an option," said Dhawan.
Mind Retirement Kitty
Some companies are giving increments in the variable component of the salary. However, this will not translate into any increase in the contribution towards the Employees’ Provident Fund (EPF) as the basic pay will remain the same. This may affect your target corpus for retirement.
“Retirement planning calculations should be looked into again. Though the statutory contributions to retirement funds may have gone down in case of salary reduction by way of increasing the variable component, it can be made up by ensuring that additional investment is continued in other voluntary retirement products such as National Pension System and Public Provident Fund," said Maheshwari.
“Whenever there is extra cash flow, one can contribute it towards retirement savings to bridge for the gap," said Dhawan.
Experts believe that the trend of the variable component being higher in salaries is here to stay. So plan your finances better and take on liabilities based on your fixed pay. Have an emergency corpus and insurance in place.
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