Income Tax Provisions On Pension

Pension is a monthly payment made by the employer after the retirement or death of the employee as a reward of past services. Its always taxable under the head income from salaries. Income tax act provides exemption if the employee has opted for commutation. Therefore, employees getting commuted pension can avail exemption benefits while paying tax.

What is commuted pension

It means a lump sum payment in lieu of the periodical pension amount surrendered voluntarily by the employee based on duration of service in relation to the age. This option is available to the employee. If the employee avails this option then a portion of the monthly pension amount will be commuted and given to the employee at a time. After receiving the commuted portion the monthly pension amount will be reduced in that proportion. Under income tax act following exemptions are available for commuted portion;

Exemption for Government Employee and non-government employees

Commuted amount received by the employee working for central government or state government or local authorities or statutory corporations is fully exempted. Please note, employees working in public sector undertakings are not eligible for full exemption as they are not considered as government employee.

Following exemption from the commuted portion is available to those employees who are not a government employee.

  1. If the employee has received gratuity then one third of the full commuted value of the pension is exempted from income tax.
  2. If the employee has not received gratuity then one half of the full commuted value of the pension is exempted from income tax.

How to arrive with the commuted value

Suppose you are entitled to receive Rs. 25, 000 per month as pension. After your retirement, you have decided to commute 50% of it to receive a lump sum amount of Rs. 26, 00,000 (calculated based on your age and duration of service).

In order to calculate exemption amount, you need to calculate the full value of the pension that you are eligible to receive but not availed. Commutation is done only for 50% of the monthly pension to get Rs 26,00,000. This means full value is Rs 26, 00,000 *2 = 52, 00,000.

If based on the above exemption limit, you are eligible for 1/3 exemption of your commuted value then your exemption will be Rs. 17, 33,333 and the balance amount of Rs. 34, 66,667 will be taxable

Uncommuted / Monthly Pension

It’s the monthly amount that a government or non government employee receive after their retirement. For both type of employees this amount is taxable. In general this uncommuted portion is the amount which is generally understood by a common man as retirement pension. There is no exemption available for this type of payment

Family Pension

Family pension is received by the family members after the death of the employee. Such amount will be taxable in the hands of the family person who receive it under the head income from other sources. Standard deduction of Rs. 15, 000 or 1/3 rd of such pension which ever is lower will be allowed as a deduction.

Family pension received by a family member being his spouse or children or nominated heir will be exempted from income tax if the person’s death occurred during the course of operational duties.

Other relevant Points

If a person is on deputation from a government job to a public sector undertaking and retires from their then the entire amount of commuted pension will be exempted from income tax as he is a government employee. Exemption is also allowed for Supreme Court judges and high court judges.

Pension received abroad for the salary rendered in India will be taxable in India even though it has been received abroad and the person receives it is non resident.

NPS – Notified Pension Scheme

This is applicable to those employees who joined central government job on or after 1st January 2004. Contribution to these funds by the central government will first be included to the salary and then to the extent of 10% of salary (Basic + DA forming part of salary) for the contribution including employee’s contribution will be available as a deduction under section 80CCD of income tax act.

When you receive pension out of this fund the whole amount will be taxable under the head salary. However the total available deduction under section 80C, 80CCC and 80CCD should not exceed Rs. 1, 50, 000 in aggregate.

As pension is always taxable in the hands of a employee we suggest that one should commute a portion of it in such a way that the monthly pension amount that he receives after such commutation comes under the basic exemption limit of income tax not chargeable to income tax and for the commuted portion he can claim exemption benefit.

Editorial Staff at Yourfinancebook is a team of finance professionals. The team has more than a decade experience in taxation and personal finance.