Retirement benefits are received by most employees at the time of retirement. A retired life of an individual begins with the liquidation of the post-retirement benefits like gratuity, provident fund, leave encashment, superannuation fund, etc. Gone are the days when one had to run from pillar to post to get the benefits as now these benefits are transferred into the bank account as soon as all formalities are done. This ensures there is a steady flow of income post-retirement. There is one aspect that many tend to forget but is very essential is computing the tax liability. Not paying the due tax can lead to several financial and legal complications.
In the hands of a Government employee Gratuity and PF receipts on retirement are exempt from tax. In the hands of non-Government employee, gratuity is exempt subject to the limits prescribed in this regard and PF receipts are exempt from tax, if the same are received from a recognised PF after rendering continuous service of not less than 5 years.
Let us talk about some of the common retirement benefits and understand the tax liability associated with them in detail:
Gratuity is a payment that an employer makes to his employee for the services provided him during his employment tenure. Mostly, gratuity is paid at the time of retirement, but if certain conditions are met, it can be paid earlier too. Any company, which has 10 or more employees on any day in the preceding 12 months is liable to pay gratuity. And if post this, the number of employees reduces, the Gratuity Act will always remain valid. The following two categories of people can receive gratuity:
- The employee at the time of the retirement
- If the employee dies, the legal heir is eligible to receive the amount
Any employee who has completed five years of employment under the employer is eligible to get gratuity. This does not imply to temporary employees and interns.
Gratuity Exemption Calculation
- A Government Employee’s gratuity amount is completely exempted from tax.
- For the employees covered by the Payment of Gratuity Act, the least of the following will be exempted:
- 15/26 X Last Drawn Salary X No of Years of Service
- Actual Gratuity Received
- For employees not covered under the Gratuity Act an equal amount which is the least of the following will be exempted:
- Rs. 10,00,000
- ½ X Average Salary of last 10 months prior to retirement X No of completed years of service
- Actual gratuity received
It must be noted that if gratuity is received during the years of employment, irrespective of coverage under gratuity act and government employee, the entire amount is taxable. If the legal heir receives the gratuity of a government employee due to the latter’s death, the full amount is exempted under section 10(10)(i). the amount of gratuity received by the legal heir of a non-government employee is taxable as per the above-mentioned limits. It is important to understand how gratuity exemption affects taxable income.
Pension received by an individual at the time of retirement can be classified into two; commuted and uncommuted pension. The former is received in one go and not in installments whereas the latter is received in installments. Uncommuted pension is taxable for both non-government and government employees. Let us discuss the tax implications of commuted pension.
- All central and state government employees along with employees of statutory corporation and local authorities are exempted from tax.
- For all other employees the tax exemption is as follows:
- For those employees who do not receive gratuity, ½ of 100% value of commuted pension (pension received/% of pension commuted)
- For those employees who also receive gratuity, it is 1/3 of 100% value of commuted pension
For those employees, who receive their pension in parts of commuted and non-commuted, then the calculation is done separately for each part.
When a family member receives pension, it is taxed as an income from other sources while filing the income tax returns. the lump sum or commuted pension is not taxable for the family member. Whereas, uncommuted pension is exempt to the following limit:
The lesser of Rs. 15,000 or 1/3 X uncommuted pension
Employees who are retiring are allowed by the employer to take encashment for a fixed number of holidays and leaves. For government employees, the total amount received for leave encashment is exempted from tax. For non-government employees the lower of the following is the exemption limit:
- Actual leave encashment received
- Average of 10 months salary
- Rs. 300,000
- Based on the average of 10 months salary, amount of the salary earned for the period of leave
At the time of retirement, there are different benefits received. The discussion on PF and gratuity exemption after retirement is talking about the two main ones. Apart from these some of the other retirement benefits are retrenchment compensation, compensation for golden handshake or VRS, payment from the provident fund, payment from a superannuation fund, etc. Often, many tend to forget about the tax implications of the amount received as tax benefits which has other complications. Understanding the liability of each and knowing about the exemption limits is essential. The exemption for government employees is more when compared to non-government employees, but the latter needs to know the exemption limits for each benefit to ensure they do not pay too much tax.
- What is the exemption limit on Superannuation Fund?
If the payment is made in the specified circumstances i.e. retirement, death and incapacitation, the payment from an approved superannuation fund is completely exempted from income tax.
- Is Pension considered as income in India?
Pension income, just like any accrued income, is taxed as per the Indian tax act as per the slabs which are decided by the government of the country. Under the section 192, of the Income Tax Act, any income which is a part of the head ‘Salaries’ which also includes pension is taxable.
- What is the tax treatment on VRS?
When an employee opts for a VRS, he is exempted from tax to the extent of Rs. 5 lakhs. This is valid for an employee for the following:
> Public sector company
> Local authority
> Any other company
> Cooperative societies, IITs, Universities and notified management institutes
> Authority established under central, state or provincial act
It must be noted that the VRS scheme of a company must be designed keeping in mind the guidelines and rules of the Rule 2BA of Income Tax rules.
- How is Provident Fund treated with respect to tax post retirement?
If the payment is received from a provident fund which comes under the purview of Provident Fund Act, 1925, the entire amount is exempted from tax liability. Also, in case of Public Provident Fund which was started in 1968, the lump sum amount received at the time of retirement is considered to be tax free. The effect of PF on taxable income is simple and does not need a mathematical formula. The employer in this case has no contribution and the employee’s contribution is exempted under 80C whereas the lump sum amount is fully exempted.