Taxation of pension

People working in government services or those working with government departments get pensions after retirement from their services additionally people who have contributed towards Employee Provident Fund (EPF) also get pension under Employee Pension Scheme (EPS), 1995. Even after the death of the employee their family members are also entitled to get the pension from the employer as well as under EPS.

Some employers contribute towards superannuation fund of employees so that they get pension after their retirement. From 2004 the government has shifted all its new joiners to New Pension System (NPS) where the amount of pension received by them  is dependent on the amount contributed by them along with the employer to the NPS. Even self employed can also contribute towards NPS account and get annuity after their retirement.

Generally the words pension and annuity are used interchangeably but strictly speaking the monthly amount received by an employee after retirement from his ex-employer or in connection with employment is called pension and periodical payments received from an insurance company on annuity policy is called annuity but such annuity is also referred to as pension.

There are different tax rules for such pension and annuity. Let us discuss.

Basic Provision for Taxability of Pension:

To discuss the tax treatment of the pension received, comprehensively, the employees have been divided in two types:

1. government and

2. non-government.

Even the pension received can be of two types:

1. Commuted and

2. Uncommuted pension

Uncommuted pension is the periodical payment of pension. For instance, X gets monthly pension of Rs. 2,000/-. It is taxable as salary under section 15 in the hands of a government as well as a non government employee.

Commuted pension is a lump sum payment in lieu of periodical payment. For instance after his retirement, X gets 25 percent of his pension commuted for Rs. 60,000/- (after commutation he will get the remaining 75% i.e. Rs. 1,500/- by way of monthly pension). In this case, Rs. 60,000/- is commuted pension which X has received in lieu of 25% of his monthly pension. The taxability of the commuted pension is dependent upon the status of the employee and whether or not such employee has received gratuity.

If such commuted pension is received by a government employee (i.e. employee of the Central Government, State Government, Local Authority and Statutory Corporation) who may or may not have received gratuity, then such commuted pension would be completely exempt from tax.

If such commuted pension is received by a non-government employee:

1. who has received gratuity – 1/3rd of the pension which he is normally entitled to receive, would be exempt from tax

2. Who has not received gratuity – 1/2 of the pension which he is normally entitled to receive is exempt from tax

If the payment in commutation of pension received by an employee exceeds the aforesaid limits, such excess pension received is liable to tax in the assessment year relevant to the previous year in which it is due or paid.

Pension received from ex-Employer

For the employees who receive pension from their ex-employer is fully taxable under the head salaries. So it is not only the active employees whose salaries are taxed under the head Salaries but also the pension receive by ex-employees is also taxed under the same head. Like Salaried employees, the pensioners are also entitled to the benefit of standard deduction available upto fifty thousand rupees every year which has been  introduced from this year,  against the pension received by them.

You are entitled to commute certain portion of your pension and receive the present value of such commuted value of pension at the time of your retirement. For government employees and those working with government companies the entire value of commute pension is exempt. However for other employees commuted value of 1/3 of pension is exempt in case the employee receives any gratuity. In case the employee does not receive any gratuity, he can commute pension upto 50% of the pension and claim the same as exempt.

Pension received under superannuation policy or employee pension scheme

In case your employer had contributed towards superannuation fund or ha purchased superannuation policy for you, the pension received by your from the insurance company is taxable under the head Salary as it is received as a result of your employment. Even for the 1/3 of the commuted portion of pension receivable under the superannuation is fully exempt.

Likewise the pension received by you under the EPS based on your contribution towards EPF is fully taxable in your hand. Since this pension is received as a result of your employment, you are entitled to claim standard deduction as discussed above.

Family pension

Pension received by the dependent of an employee is called family pension and is fully taxable in the hands of the dependent recipient/s. However as the pension is not received due to services rendered by the dependent the same is taxable under the head “Income From Other Source”. However the dependent person who receives the pension is entitled to claim a deduction of 1/3 of the pension received subject to a maximum of fifteen thousand rupees against the deduction of forty thousand rupees available to retired employees.

Please note pension received by family members of Armed Forces is exempt.

Annuity received from insurance company on the annuity policy purchased by you

In order to ensure that you receive a certain sum at a fixed period, you can buy an annuity plan from an insurance company which in turn will pay the agreed amount at the agreed interval which is annuity but  loosely called pension. The amount of pension received under an annuity plan is fully taxable under the head “income from other Sources.” Since this amount does not have any co-relation with any employment, you are not entitled to claim standard deduction against this amount.

Annuity received from annuity policy purchased on maturity of  NPS account.

The employees who have opted for NPS instead of EPF account have to mandatorily buy an annuity plan from an Indian insurance company for 40% of the accumulated corpus. The pension received by these employee should be taxable under the head Salaries but since the employee can continue to contribute to his NPS account even after he leaves his employment or even when he turns self employed, it is doubtful whether in such situation the annuity received will become taxable under the head Salaries or it should be taxable under the head “Income From other Sources”. Likewise even a self employed person can also contribute towards the NPS account and receive pension. Presently the income tax law does not have any clear cut provision as to the head under which the annuity received for annuity policy bough on retirement should be taxed. In my opinion for the salaried the pension should be taxable under the head Salaries and should also be entitled for standard deduction upto Fifty thousand rupees. But Since the law is silent on this aspect it is risky to offer it under the head Salaries for claiming the standard deduction. Additionally salaried and self employed both can contribute additional fifty thousands to claim deduction under Section 80 CCD(1B) so the head under which the pension received will become taxable and whether one will be entitled to claim standard deduction is a grey area and clarificatory amendment of the law is needed to clear the clouds.

The writer is tax and investment expert.