Sunday, April 01, 2012

Which is better, higher monthly income or higher bonuses ?

Thought I'd share something with blog readers because I'm pretty surprised some people actually may not be able to to understand this concept and may make serious career mistakes in their lives.

Suppose your income is $120,000 a year. You have a choice between getting it over 12 pay-checks at $10,000 a month or getting getting it over 15 pay-checks of $8,000 with 3 month bonus for average performers.

Intuitively, the former the pay scheme is a superior one. Reasons can be very valid, a monthly income of $10,000 is useful for negotiating salary for subsequent jobs. You also get more money earlier on throughout the year which allows you to farm your money into investments earlier. There is also little pressure to perform at work as salaries are fixed.

Actually, if you offer me a choice of two pay schemes, I'd actually choose the latter.

Here's why:

a) CPF contribution caps are higher with the latter scheme.

One of the funny things about the CPF program is that the employer will contribute CPF up to $5,000 month. This means that you only pay CPF for up to $60,000 a year for your monthly income.

However, the CPF board has an Additional Wage Ceiling of $25,000 which allows an employee to contribute part of their bonuses to the CPF program with the appropriate matching from your employer.

This means that the former pay-scheme, your employer pays CPF up to $60,000 of your income but in the latter payment scheme, your employer has to match up to $84,000 of your income.

Many HR departments in Singapore have saved a lot of money by offering to pay their employees based on a 12 month fixed scheme instead of paying them bonuses. Employees happily accept those terms because it's more cash in hand and the program was touted as being income neutral. In actual fact, the employer is creating huge savings for themselves by contributing less to employee CPF.

b) The problem of higher taxes.

In many cases, when employees get more money, their contribution to CPF drops which means that more income becomes taxable. This actually means more money paid to the government.

To prevent manipulation and gaming of the CPF system, we will be better off simply setting the ceiling to be indifferent to whether the income is normal monthly income or bonus income. Simply limit a year of income matching to $85,000 regardless of the nature of the income for each employee.

This way companies cannot exploit workers by switching to a 12 month payment program and declaring that the switch is income neutral.

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