How Are Retirement Benefits Taxed in India?
The Income Tax Act, 1961 states that income earned either as salary or by other means is taxable as per the applicable income tax slab.
When you begin your retirement life, you start receiving certain kinds of retirement benefits. Benefits such as gratuity, pension, provident funds, Voluntary Retirement Schemes (VRS), leave encashments, and Dearness Allowance (DA) are registered as retirement benefits under Indian Laws.
As these benefits are meant for enjoying post retired life without any financial worries, it is advisable to have knowledge about the tax implications on them. While most retirement proceeds are tax-efficient in nature, you will have to pay a certain percentage of taxes depending on your tax slab. Further, the Income Tax Act has different provisions for calculation of taxability & exemptions for Government & Non Government employees.
The tax implications on your retirement benefits have been discussed below:
Provident funds (PF) are entirely tax free under Indian IT laws. However, there are certain conditions for the entire PF to be tax-exempt:
- The provident fund scheme by the employer should be registered under the PF Act.
- You should be an employeer of the company for at least 5 years.
However, if your employer has invested in some privately managed provident fund scheme, the scenario can be otherwise. The employer’s contribution and interest accrued are taxable. In case of an Employee Provident Fund (EPF), if an employee’s own contribution to the EPF along with excess contribution to Voluntary Provident Fund (VPF) exceeds Rs 2.5 lakh in a financial year, then the interest earned on excess contributions will be taxed.
A pension is not tax-exempt like provident fund but is taxable under the Income Tax Act. Before understating taxation on pension, it is important to understand that there are two types of Pension:-
1. Uncommuted Pension: The pension amount that is received periodically. Any amount received as Uncommuted Pension is fully taxable in the hands of both government and non-government employees.
2. Commuted Pension: Commuted pension means amount of pension received in lump sum. For example, if Ram is eligible for a total pension of say Rs.10 lakhs, he can opt to seek Rs. 5 lakhs in one go and rest in periodic instalments. Commuted or lump sum pension may be tax-exempt in following instances:
- For a government employee, commuted pension is fully exempt.
- For a non-government employee, if 100% pension is commuted it is partially exempt. The conditions are as follows:
- If gratuity is also received with pension, then 1/3rd of the amount of pension that would have been received, if 100% of the pension was commuted, is exempt from taxes.
- If only pension is received and gratuity is not received, then 1/2 of the amount of pension that would have been received, if 100% of the pension was commuted, is exempt.
New Pension Scheme (NPS)
NPS or New Pension Scheme is a relatively new retirement plan introduced by the Government of India. The Pension Fund Regulatory and Development Authority (PFRDA) regulates all frameworks with regard to NPS, including legalities and investment process.
There are specific withdrawal rules for this scheme. You cannot withdraw the entire maturity amount at the time of retirement, only 60% of the NPS corpus can be withdrawn as lump sum upon attaining superannuation age (60 years). You have to use 40% of the amount to buy an annuity plan, to receive regular income. While the lumpsum amount is free from taxation, you have to pay taxes on the annuity payments as per the applicable income tax slab.
If you have been working in an organisation for a minimum of 5 years, you are eligible for Gratuity. Under the Payment of Gratuity Act, 1972 you are eligible for this benefit if you have been employed in factories, mines, ports, railway companies, oilfields, plantations, shops or other establishments with ten or more employees. However, even if the organisation is not covered under the Payment of Gratuity Act, there is no law that restricts an employer from paying gratuity to his employees.
This benefit comes tax free for government employees and for private sector employees, there are some conditions for it to be tax-exempt.
If you are covered under the Payment of Gratuity Act, the least of the following is tax-exempt:
- Last salary (basic + DA)* number of years of employment* 15/26;
- Rs. 20 lakhs (hiked from Rs. 10 Lakh as per the amendment);
- Gratuity actually received
If you are not covered under the Payment of Gratuity Act, the least of the following are exempt from tax:
- Last 10 month’s average salary (basic + DA)* number of years of employment* 1/2
- Rs. 10 lakhs (Rs. 20 lakhs hike is not applicable for employees not covered under the Payment of Gratuity Act)
- Gratuity actually received
Let’s assume, Ram has been in employment for 25 years and 2 months. The average salary for the last 10 months is Rs. 90,000.
|Average of last 10 month’s salary||90,000|
|Number of years of employment||25 (will be rounded off)|
|Gratuity||90,000*25*1/2 = 11,25,000|
|Maximum exemption allowed||10 lakhs|
|Gratuity actually received||11 Lakhs|
|Amount of exemption (least of the three)||10 Lakhs|
|Taxable Gratuity||1 Lakh|
Voluntary Retirement Scheme
Under the Voluntary Retirement Scheme (VRS), also known as the “Golden Handshake” between an employer and the employee, the amount can be tax-free only if it is less than Rs. 5 lakh under Section 10(10C). However, you should remember that you are only eligible for VRS if you have completed a minimum of 10 years of service in a particular organisation and are at least 40 years of age. Further, the scheme applies to all employees except directors of a company.
There is no specific law by the Government for leave encashment. This policy varies for each organisation. Every salaried person as per labour law is entitled to a minimum number of paid leave every year. However, it is not necessary that you will utilise all the leaves for a year. Hence, most employers allow employees to carry forward such unutilised paid leaves.
At the time of retirement or resignation, the employer compensates the unutilised paid leave of the employees. However, some fundamental differences exist for public and private sector employees with regard to tax on leave encashment.
Government employees are not liable to pay any tax on their leave encashment amount at the time of retirement.
Non-government employees have to pay taxes on their leave encashment amount, as mentioned under Section 10 (10AA) of the Income Tax if it exceeds a certain amount. This is taxable under the income from the salary head of the Income Tax Act.
Exemption under Section 10(10AA) is applicable on the lowest of the following amounts:
- Amount of Rs. 3 lakh
- Actual leave encashment amount
- Cash equivalent of pending leaves (Only applicable for a maximum of 30 days leave for every year of service)
- The average salary for the last 10 months before the employee’s retirement or resignation
The retirement benefits and their tax implications mentioned in this article are applicable to any Indian citizen who is engaged in either public or private sector companies. Assessing the tax on retirement benefits will help you plan your retirement fund accordingly and make the necessary changes to your post-retirement financial planning.
Frequently Asked Questions
Is my pension taxable as income in India?
As per Section 192 of the Income Tax Act, any income which comes under the head “Salary” is taxable as per the taxable income tax slab for that financial year. Pension does come under the salary head and is hence taxable as income in India.
What are the conditions for tax exemption of superannuation funds?
If the payment of a superannuation fund is made under certain scenarios such as death, incapacitation and retirement, these payments are wholly tax exempt if done from a recognised fund.
Which insurance firms are registered under PFRDA for the NPS scheme?
Here are the insurance companies that are registered under the PFRDA:
– SBI Pension Funds Pvt. Ltd.
– LIC Pension Fund Ltd.
– UTI Retirement Solutions Ltd.
– HDFC Pension Management Co. Ltd.
– ICICI Prudential Pension Fund Management Co. Ltd.
– Kotak Mahindra Pension Fund Ltd.
– Aditya Birla Sunlife Pension Management Ltd.
– Tata Pension Management Ltd.
– Max Life Pension Fund Management Ltd.
– Axis Pension Fund Management Ltd.