1) Voluntary pension fund
Pension funds and retirement planning go hand in hand. A typical pension scheme involves making a voluntary contribution during one’s working life. The pension fund in turn invests it to create a corpus and pays a pension income to the individual on his/her retirement.
A 39-year-old salaried individual contributes Rs 10,000 monthly to an eligible pension fund and is planning to retire at 45 years. On his retirement, he/She will receive a monthly pension of Rs 12,000 from this pension company. His taxation would be as follows:
Pre-retirement, the contribution to the pension fund of Rs 1,20,000 is allowed as a deduction from his taxable income up to an aggregate amount of Rs 100,000 under Section 80C of the Income-Tax Act. He/She being in the highest bracket would get a tax break of Rs 33,900 on this account.
On his retirement, his monthly pension will be taxed as salary at the applicable slab rates. Where He/She opts for a commuted amount of pension at the time of retirement (i.e., lump sum amount instead of periodic payouts), the same will be tax free in his hands.
Commuted amount of pension is determined with regard to the age of the recipient, health, the rate of interest and officially recognized tables of mortality. While taking a lump sum option may be beneficial from a tax perspective, He/She will need to ensure such a commuted amount lasts him a lifetime, unlike a monthly pension, which is anyway assured for life.
2) Employer’s pension fund
The monthly pension from the employer would also be taxed as salary, as discussed earlier. However, where the employee passes away and his family receives a monthly pension from his employer, the tax treatment would differ. This monthly pension received would be taxed as ‘Income from Other Sources’ in the hands of the family member receiving the pension, a deduction of one-third the pension amount up to Rs 15,000 is allowable.
Taxation of lump sum (commuted) pension from the employer on retirement depends on whether gratuity is also given to the employee. Let us consider the example of a person who is eligible for a lump sum pension of Rs 250,000 at time of retirement.
Commuted pension received by this person would be exempt to the tune of Rs 83,333 (i.e., one third of the pension amount) where this person is eligible to gratuity and to the extent of Rs 125,000 (i.e., half) where this person is not eligible to gratuity.
The gratuity this person receives is tax exempt to the extent of half-a-month’s salary (average of past 10 months’ salary) for each year of completed service, limited to Rs 350,000. Where gratuity was claimed exempt in earlier years, only the unutilized portion of Rs 3,50,000 is permissible as exemption.
Pension funds and retirement planning go hand in hand. A typical pension scheme involves making a voluntary contribution during one’s working life. The pension fund in turn invests it to create a corpus and pays a pension income to the individual on his/her retirement.
A 39-year-old salaried individual contributes Rs 10,000 monthly to an eligible pension fund and is planning to retire at 45 years. On his retirement, he/She will receive a monthly pension of Rs 12,000 from this pension company. His taxation would be as follows:
Pre-retirement, the contribution to the pension fund of Rs 1,20,000 is allowed as a deduction from his taxable income up to an aggregate amount of Rs 100,000 under Section 80C of the Income-Tax Act. He/She being in the highest bracket would get a tax break of Rs 33,900 on this account.
On his retirement, his monthly pension will be taxed as salary at the applicable slab rates. Where He/She opts for a commuted amount of pension at the time of retirement (i.e., lump sum amount instead of periodic payouts), the same will be tax free in his hands.
Commuted amount of pension is determined with regard to the age of the recipient, health, the rate of interest and officially recognized tables of mortality. While taking a lump sum option may be beneficial from a tax perspective, He/She will need to ensure such a commuted amount lasts him a lifetime, unlike a monthly pension, which is anyway assured for life.
2) Employer’s pension fund
The monthly pension from the employer would also be taxed as salary, as discussed earlier. However, where the employee passes away and his family receives a monthly pension from his employer, the tax treatment would differ. This monthly pension received would be taxed as ‘Income from Other Sources’ in the hands of the family member receiving the pension, a deduction of one-third the pension amount up to Rs 15,000 is allowable.
Taxation of lump sum (commuted) pension from the employer on retirement depends on whether gratuity is also given to the employee. Let us consider the example of a person who is eligible for a lump sum pension of Rs 250,000 at time of retirement.
Commuted pension received by this person would be exempt to the tune of Rs 83,333 (i.e., one third of the pension amount) where this person is eligible to gratuity and to the extent of Rs 125,000 (i.e., half) where this person is not eligible to gratuity.
The gratuity this person receives is tax exempt to the extent of half-a-month’s salary (average of past 10 months’ salary) for each year of completed service, limited to Rs 350,000. Where gratuity was claimed exempt in earlier years, only the unutilized portion of Rs 3,50,000 is permissible as exemption.
