Salary Reduction: The hidden cost that will ruin your retirement

A recent post on LinkedIn has caught our attention and struck a nerve: 50% Salary Cuts in the UAE. Are They Legal? The author concluded that yes, such a drastic move is possible, as long as it's fully documented and supported by the employee’s written consent. Without that, it constitutes a clear breach of UAE labour law.

What might seem like a selfless and heroic act by employees has however a massive negative impact on their End of Service Benefit (EOSB) Gratuity.

Impact on EOSB Gratuity

Let us say Ahmed, a loyal and hard-working employee, is currently making 10,000 AED per month in basic salary. Having started work for the firm exactly 30 years ago, his End of Service Gratuity as accumulated to AED 235,000. Ahmed plans to use this substantial sum to buy himself a retirement cottage back home once he retires in 10 year's time.

Being a very loyal employee, he listened carefully to his boss who said that given the crisis, belts must be tightened. The boss pressures Ahmed into agreeing to this, in order to help saving the company. Despite some lingering doubts Ahmed finally signs papers which reduce his basic salary down to 5,000 AED.

Was that a smart move? Ahmed was not aware that the End of Service Benefit (EOSB) gratuity under the traditional system is calculated on the basis of the last salary. Which is now halved, down to 5,000 AED from previously 10,000 AED.

Consequently, Ahmed's gratuity has been halved too, from AED 235,000 down to AED 117,500 only.

That is bad news for Ahmed and his retirement dreams.

The small print matters

It is worth to note that the UAE labour law recognizes two kinds of salary cuts: temporary and permanent. In short, EOSB remains unaffected under temporary salary cuts, whilst it may be affected - as per example above - in the case of permanent cuts that have been documented and signed by way of an amendment to the labour agreement.

The small print matters - and in case employees are faced with such demands by their employers, we always recommend taking legal advice to ensure that their EOSB remains unaffected.

Help is on the way

In any case, as many may have heard already, help is on the way: With introduction of Cabinet Resolution 96/2023, a new way of End of Service Benefit gratuity is being introduced in the UAE. (If you're new to the topic, please find a short description of the new system here).

The new system has several interesting features, which makes it more attractive to both employers and employees.

In the specific case of salary reductions, it is interesting to note that employees' EOSB gratuity remains largely unaffected. Why?

Firstly, becuse employers make payments "pay as you go", month after month, in cash, to an external fund manager. The money is there, it is invested, and is no longer affected by salary changes up or down.

Secondly, the legacy gratuity (= the gratuity that has been accumulated up & until the time of switchover to the new system) is frozen at that time, and also no longer affected by salary changes.

The only part of EOSB that is affected are the contributions going forward, as they are calculated as a percentage of salary.

Conclusion

Truth to be told, we don't really like the practice of salary reductions, not least because of the detrimental consequnces on EOSB gratuity. It is easy to see how uninformed workers fail to grasp the consequences of this and lose out on their hard-earned gratuity benefit. One more reason to hope that he new EOSB Saving Schemes will be rolled out across the UAE as soon as possible!