Retirement Benefits and Tax Liabilities

1. Retired life begins with liquidation of retirement benefits such as Provident Fund , Gratuity , Leave Encashment , Superannuation Fund & Pension.These retirement benefits,which have been built over decades of discipline savings are meant for enjoying post retired life without any financial worries.

2. A person on the verge of retirement, need to consider managing retirement benefits. Retirement proceeds are by default tax-efficient in nature. Income Tax Act has different provisions for calculation of taxability & exemptions for Government & Non Government employees.

3. Government & Non Government Employee : Government & Non Government employees are treated differently in the eyes of Income Tax Act. In most of the cases , retirement benefits are exempted for Government employees.

3.1 A person employed with a Central or State Government Organization are termed as Government Employee.

3.2 Non Government employees are those working with Private Sector, Public Sector Undertakings & Government Companies. Though common people still do not differentiate between PSU or Government employee but there is a substantial difference in tax exemptions, pay structure, perks and terms of employment in these two types of employment.

4. A simple Anylises of various types of retirement benefits & tax liabilities and has been brought out in succeeding Paragraphs

5. Provident Fund : Lump Sum Provident Fund as a retirement benefit consists of employee’s own contribution , Employer’s contribution and interest credited over the years.The entire corpus is exempted from tax subject to the following conditions:-

(a) Employee should be in continuous service for a period of last 5 years.

(b)The Provident Fund Account maintained by the employer should be Recognized under PF Act

5.1 Many employees don’t withdraw the PF corpus after retirement thinking that they will get tax free interest from accumulated PF corpus. However, Interest earned on post retirement contribution to EPF is taxable Hence; it is recommended to withdraw the PF corpus at the time of retirement.

6. Gratuity : Gratuity’ is a retirement benefit to the employee who have rendered not less than 5 years of continuous service to the employer.

6.1 Calculation of Gratuity Amount : In case of employee covered under the Payment of Gratuity Act , the amount is calculated as a proportion of monthly salary multiplied by the total years of completed service.

For Example : An employee last drawn salary ( Basic + DA ) at the time of retirement is Rs 1,30,000/- and he has completed 28 years of service. Gratuity amount will be calculated as-

{(130000*15/26 ) * 28}= Rs 21,00,000/-

6.2. Tax Exemption : The Income-tax Act, 1961 exempts Gratuity tax free for Government employees. For Non Government employees covered under Payment Of Gratuity Act 1972, the maximum limit for exemption is Rs 20 lakhs

6.3 The employees engaged in factories, mines, oilfields, plantations, ports, railway companies, shops or other establishments with ten or more employees are covered under Payment of Gratuity Act, 1972

7. Leave Encashment There is no separate law on leave encashment but a lot of companies give this facility to employees. Each company has a different leave encashment policy. Some may allow employees to continue their leave balance without any limit, while some put a cap on the number of accumulated leave at any point of time.

7.1 Government employees are not liable to pay any tax on leave encashment income at the time of superannuation or resignation. The income received by non government employees as leave encashment after retirement is exempted up to certain amount based on the computation provided under Section 10(10AA) and the balance amount, if any, is taxable as income from salary

7.2. Exemption under Section 10(10AA): A part of the leave encashment income at the time of superannuation or resignation is exempt from income tax payment. This exemption is applicable to the lowest of the below amounts:

(a) Rs. 3 lakh

(b) Actual leave encashment amount

(c ) Average salary (basic salary + dearness allowance) of the last 10 months before the employee’s retirement or resignation

(d) Cash equivalent of pending leave days. The leave basis is a maximum of 30 days leave for every year of service

7.3 Illustration : An employee who has completed 28 years of service and his last drawn salary ( Basic + DA ) is Rs 1,30,000/-. Leave Balance at the time of retirement is 330 days. (As per company’s policy, maximum accumulated leave that can be en-cashed at the time of retirement is 300 days). Exemption amount will be the lowest of the amount arrived as follows: –

(a) Maximum limit as per I Tax Act Rs 3,00,000

(b) Actual Leave Encashment : (1,30,000/30)* 300 Rs 13,00,000

(c ) Average salary ( Basic+DA) of the last 10 months Rs 1300,000

(d) {(30*28)- 510} = (330 * 1,30,000/30) Rs 14,30,000

[{( Leave entitled per year * years of service )- Leave availed}* Salary per day ]

7.3 Taxable L. Encashment Amount: Rs ( 13,00,000-3,00,0000 )= Rs 10,00,000

8. Superannuation Pension : Amount invested directly or through the employer in superannuation pension policy will mature at the time of retirement. The maturity amount is normally paid in the form of a partial lump sum payment with the balance invested in annuities for generating a fixed monthly or periodic income. 1/3 rd of the maturity amount paid as a lump sum and 2/3rd will be invested in annuities

8.1 If the maturity amount is Rs. 10 Lakhs , then one may get Rs. 3 lakhs as a lump sum payment with the balance amount used to generate a fixed monthly income after retirement. The lump sum payment is called the commuted pension. The amount invested in annuities is un commuted pension.

8.1.Illustration :

8.2 Rs 7 Lakhs wil be converted into a regular pension, which is in turn kept in the annuity fund for receiving annuity returns at chosen intervals.

8.3 1/3rd of commuted pension is exempted from tax and the remaining amount is taxable.

9. New Pension Scheme New Pension Scheme, popularly known by its acronym NPS is a Government sponsored pension scheme in which the contributions are invested in a mix of assets. The retirement corpus is dependent on the returns from those assets. A person investing n this scheme is requires to utilize at least 40% of pension corpus to buy an annuity at the age of 60.

9.1.Withdrawal Rules Entire corpus of the NPS scheme cannot be withdrawn at the time of retirement. It is compulsorily required to keep aside at least 40% of the corpus to receive a regular pension from a Pension Fund Regulatory Development Authority ( PFRDA) registered insurance firm. Followings are the insurance firms registered with PFRDA for the purpose of NPS scheme :

HDFC Pension Management Company
ICICI Prudential Life Insurance Company
Kotak Mahindra Asset Management Company
LIC Pension Fund
SBI Pension Funds
UTI Retirement Solutions
Birla Sun Life Pension Management

9.2. The remaining 60% corpus withdrawal from NPS scheme is tax-free now.

10. There are many good financial planners in India whose advise can be obtained for investment of Retirement benefits in a productive way.