Pension is a periodical payment made by the employer after the retirement or death of employees. Pension is fully taxable under the head income from salaries in the hands of all employees. However, employees of UNO and central government employees who have been awarded gallantry awards is fully exempted.
It’s also known as retirement pension, as periodical payments are made after employee gets retired.
However, the government has allowed exemption on commuted pension based on the type of employer.
What is commuted pension and when exemption is allowed
Employees have the option to forgo a portion of the periodical pension to receive a lump sum amount under pension rules. Its referred as commuted pension. This means employee has converted part of future right of getting pension into a lump sum consideration receivable immediately. Commuted part is eligible for exemption under section 10(10A) of the income tax act,1961.
The remaining portion after commutation will be periodically received, its known as un-commuted pension.
Exemption as provided in section 10(10A) of the income tax act can be divided as follows based on the type of employer:
- In case of government employees or employees of local authorities or statutory corporation.
- In case of other employees.
In the first case, commuted pension is wholly exempted under section 10(10A)(i). This means commuted pension received by employees of government or local authorities or statutory corporations is wholly exempted. Vide circular number 623 dated 6/01/1992, it has been clarified that judges of high courts and the supreme court are also entitled to the exemption.
In case of all other employees, commuted pension is exempted to the following extent:
- ⅓ of the total eligible commuted value of the pension is exempted from tax if the employee also receives gratuity.
- ½ of the total eligible commuted value of the pension will be exempted in case the employee does not receive any gratuity.
Please note, exemption is not to be calculated on the lump sum amount you received after commutation. It’s to be calculated on the full commuted value of the pension the employee is entitled to receive.
Full commuted value of pension = lump sum commuted amount received by assessee * percentage of commutation
Example to understand the applicability of exemption provisions
Mr X was a government employee retired from service. After retirement, he is eligible for a monthly pension of Rs 20,000. He commuted half of his monthly pension in order to get a lump sum amount. Due to this commutation, he receives Rs 4,00,000 as lump sum payment.
In this case, Mr X will be getting Rs 10,000 per month as his pension. This amount will be taxable under the head income from salaries.
The lump sum received due to commutation is eligible for exemption under section 10(10A). As Mr X is a government employee, the whole commuted pension as per rules is eligible for exemption under section 10(10A)(i).
When Mr X was a non-government employee
By assuming Mr X is not an employee of the government or local authorities or statutory corporation,let us calculate his gross salary. As stated earlier in our article, pension is always taxable irrespective of the type of employer. Hence pension of Rs 10,000 per month will be included in the gross salary of Mr X.
In case of commuted pension, we have to know whether Mr X is entitled to gratuity or not. If Mr X has received gratuity, then ⅓ of the total commuted value of pension is exempted or else ½ of the total commuted value of pension is exempted.
Exemption calculation when Mr X is entitled to gratuity
- Total commutation value of pension = lump sum commuted pension amount received by assessee * percentage of commutation = Rs 4,00,000 * 50% or (Rs 4,00,000 / Rs 10,000) * Rs 20,000 = Rs 8,00,000
- Exemption under section 10(10A)(ii) = ⅓ of Rs 8,00,000 = Rs 2,66,667
- Taxable commuted pension = Rs 4,00,000 – Rs 2,66,667 = Rs 1,33,333
Rs 1,33,333 is to be included in gross salary calculation.
Exemption calculation when Mr X is not entitled to gratuity
As per section 10(10A)(ii), in case assessee is not entitled to gratuity then ½ of the total commuted value of pension is eligible for exemption. Therefore, in this case ½ of Rs 8,00,000 = Rs 4,00,000 is exempted. Balance Rs 4,00,000 will be included in the calculation of gross salary.
Please note, pension is always taxable for all government employees and non-government employees. While calculating tax on commuted pension, you will be eligible for exemption under section 10(10A).
Pensioners are also eligible for section 16 deductions from their gross salary. Therefore, for assessment year 2019-20 (previous year 2018-19), pensioners are eligible to get Rs 40,000 as standard deduction under section 16(i).
For assessment year 2020-21 (previous year 2019-20), standard deduction limit under section 16 has been increased from Rs 40,000 to Rs 50,000. Therefore, from gross salary of previous year 2019-20, you can claim Rs 50,000 as standard deduction under section 16(i).
This standard deduction has replaced the earlier allowed exemption of Rs 15,000 for medical reimbursement and Rs 19,200 towards transport allowance. From previous year 2018-19, assessee will not be allowed to claim medical reimbursement of Rs 15,000 and transport allowance of Rs 19,200.
Income tax on family pension
After the death of employee, the legal heirs receive pension. In such cases, its referred as family pension. As in this case, the relationship between legal heir and payer is not employer and employee, it will not be taxable under the head income from salaries. Therefore, it will be taxable under the residual head “income from other sources” subject to deduction under section 57.
Under section 57, legal heir of the pensioner can claim least of the following as deduction;
- ⅓ of the pension amount, or
- Rs 15,000
However, in the following two cases family pension will be fully exempted under section 10(18)and 10(19) of the income tax act, 1961:
- Family members of central government employees who have received gallantry awards.
- Family members of armed forces.
As per circular number 573 dated 21/08/1990, commuted pension received by the widow or other legal heirs of an employee who dies while still in active service are not taxable.
TDS on pension
As per income tax provisions, payer is required to deduct tax at source on certain specified transactions while making payment or credit to the party. For instance while paying salary to employees, the employer is required to deduct tax based on the taxable income of the previous year.
Similarly, while paying pension, employer is required to deduct tax at source under section 192 of the income tax act, 1961 based on the average rate calculated per month for the total tax liability of the previous year. If the pensioner is eligible for deductions, then proof of that can be submitted in order to deduct less tax.
Income tax return for pensioners in India
Income tax return has to be filled on or before the due date in ITR-1 if income exceeds the basic exemption limit. A different income tax return form may be applicable to you based on the type of other income that have been earned during the previous year. Pensioners are required to disclose their taxable pension under the income from salaries while filing tax return.
You can reduce your tax liability by taking benefit of deductions under chapter VI-A based on your eligibility. Here are all the deductions applicable to an individual under chapter VI-A:
- Section 80C – in respect of life insurance premia, contributions to PPF, Tution fees etc
- 80ccc – in respect of pension fund
- 80ccd – in respect of contribution to national pension system
- 80ccg – in respect of investment made under any equity saving scheme
- 80d – in respect of medical insurance premia
- 80dd – in respect of maintenance including medical treatment of a dependent being a person with disability
- 80ddb – in respect of medical treatment
- 80e – in respect of payment of interest on loan taken for higher studies
- 80ee – in respect of interest on loan taken for residential house property
- 80g – in respect of donation to certain funds, charitable institutions etc.
- 80gg – Deduction in respect of rent paid
- 80gga – In respect of certain donations for scientific research or rural development
- 80ggc – in respect of contribution given to political parties
- 80ia – in respect of products and gains from industrial undertakings or enterprises engaged in infrastructure development.
- 80iab – in respect of profits and gains by an undertaking or enterprise engaged in the development of special economic zone.
- 80ib – in respect of profits and gains from certain industrial undertakings other than infrastructure development undertaking.
- 80iba – in respect of profits from housing project
- 80ic – in respect of profits and gains of certain undertaking in certain special category of states
- 80id – in the case of hotels and convention center in NCR
- 80ie – in respect of undertaking in north-eastern states
- 80jja – in respect of profits and gains from the business of collecting and processing of biodegradable waste.
- 80jjaa – in respect of employment of new employees
- 80qqb – in respect of royalty income of authors
- 80rrb – in respect of royalty of patents
- 80tta – in respect of interest on deposits in saving accounts
- 80u – in case of a person with disability