It's either this month or the next. Your pay cheque is going to show that once-in-a-year change—the salary hike. From the rate of growth of the economy down to annual salary and job surveys, every indicator is pointing to the possibility of a big raise. Especially if you have been a performer. But have you thought of what you could do with the raise—beyond a special meal or a new outfit?
How well you manage your salary increment can make a difference to your financial fortunes. MONEY TODAY spoke to three financial planners—Kolkata-based Brijesh Dalmia, Mumbai-based Jayant Pai and Bangalore-based B. Srinivasan—to figure out what kind of financial moves you can make to increase the value of the extra cash in your future pay cheques exponentially over time. Following are seven suggestions:
Understand the tax implications
First things first. Your real raise will be what you will get in hand after paying taxes. Depending on your existing income level, it’s quite likely that income tax will eat away a substantial part of your hike. In some cases it may reduce your real salary to the levels lower than the pre-increment salary. For instance, if your current annual gross salary is Rs 3,48,000 and you have made tax saving investment worth Rs 1 lakh (maximum allowed in a year under Section 80C of the Income Tax Act) your total annual tax works out to be Rs 25,092. If your salary goes up by 17% (or Rs 5,000 a month), your annual tax liability will go up by 72% to Rs 43,248. Alternatively, if you get an even bigger raise of Rs 10,000 a month (which is 35%), your tax liability will rise by 145% to Rs 61,608 a year.
Revisit your financial goals
With a pay raise you can achieve some of your financial goals faster, or make those goals more ambitious. Suppose you had set a target of building a corpus of Rs 5 lakh by March 2011. You set this target in March 2006 and started contributing Rs 6,500 a month from April 2006 with an average return of 10%. With this year’s increment in hand, if you raise your contribution by Rs 1,000 a month to Rs 7,500, you will get your corpus six months ahead of your original target. If you increase your contribution by another Rs 1,000 next year, you can reach your target one year in advance.
Especially the debts in the form of personal loans and credit card dues. Personal loans carry an interest rate of 18% a year and credit card payments, if revolved, cost 30% or more annually. Use the raise to get out of these debts that may have accumulated over the past months. If you are servicing a home loan, its good time to prepay part of it given the perpetually rising interest rates. On a loan of Rs 10 lakh taken for 20 years, if you want your EMI and repayment period not to change at all, you will have to make a prepayment for Rs 70,000 every time interest rates rise by 1%.
Build an emergency fund
If you don’t already have one, start now by using the raise to build one. Typically three months’ living expenses should always be kept as emergency fund. The money should be kept in savings or sweep-in bank account, or liquid mutual funds or any other instrument from which cash can be withdrawn at a notice of 24-48 hours or less. If your salary is low, start with a fund that will take care of essential expenses and rent, if you are living in a rented house. If you already have a fund, rebalance it to meet the change in income.
Create a nest egg
In all probability you have already created a nest egg for retirement. If you haven’t so far, and have only been thinking of it, start right away. If you contribute just Rs 1,000 a month into Public Provident Fund at the current interest rate of 8% in 15 years you will build a fund of Rs 3,45,000. For people with more cash, PPF offers even better prospects; not to forget the tax benefits when investing and also at the time of withdrawal.
Start an SIP
Systematic investment plans (SIPs) are one ideal way to build wealth in small doses—something that’s ideal to park increments. Now SIPs start from as little as Rs 500 a month. Two of the better performing mutual fund SIPs, ICICI Prudential Services Industries and Kotak Lifestyle have given 32.13% and 23.41% return in the past one year. Reason enough for you to look at them.
Buy a gift
The pay hike is the pat on the back you were expecting. But what about other important people in your life? We end this “to do” list with things beyond pure financial prudence. Buy a gift for your spouse, children and others close to you. For what is the worth of finances if they can’t help you build good relationships?
No financial advisory can be all inclusive. There will be specific needs of each person. But the thumb rule financial planners propagate for use of pay hikes is that it should be used for long-term benefit—such as getting out of debt or saving for retirement. Don’t blow it all on a new car or on items that could get you deeper into debt.