Pension is the payment received by an individual or his/her spouse on attaining the official age of retirement from a fund that is generated with regular payments towards it (PF) during the employment years. Just as employees can be categorised as government employees and non-government employees, there are two ways in which pension is received by them on retirement.
One should know that just like salary, the pension is fully taxed and it will fall under the head "Income from Salaries" in your Income Tax Returns form as long as the pension receiver lives.
Pensions are paid monthly like salary or if the pensioner chooses to, it can be paid in lumpsum. If you chose to receive a part of it in advance, it is known as a commuted pension. Before we understand the tax implications on pensions, it is necessary to understand the difference between commuted and un-commuted pension.
What is the difference between commuted pension and non commuted pension?
After your retirement, you may need a lump sum amount to invest in a house that you wish to relocate to or any other reason. In order to do so, you will have to forego an extent of your pension amount for the some of your retirement years (up to 15 years) in return for a lump sum. This lump sum is known as the commuted pension, while the rest is called un-commuted pension. On completion of the 15 years, the pension amount will be restored to the original extent.
Civilian government employees can commute a maximum of 40 percent of their pension while defence personnel can commute up to 50 percent. Additionally, the defence personnel will still receive the complete dearness allowance during those years because only the basic will be reduced.
The difference between the two can be further understood from the following example. If you choose to get 10 percent of your total pension for 15 years commuted, and your monthly pension is say, Rs 10,000, your lump sum will be 1,000 (10% of 10,000) x 15 (years) x 12 (months per year) = Rs 1,80,000 and for the next 15 years you will receive Rs 9,000 (10,000-1,000) as your monthly pension. Rs 10,000 will be restored as regular monthly pension after you are 75 years old.
Tax Implications on Pensions
Un-commuted pension (regular monthly payments):
The tax calculation on pension received is the same as that on salary for a government as well as private sector employee. As in the above example, the Rs 9,000 and the Rs 10,000 (after 15 years) will be fully taxable. You can claim a standard deduction of Rs 40,000 like you could with salaried income for the current financial year 2018-19.
It is fully exempt from tax for government employees.
For private sector employees:
- If received with gratuity: One-third of the extent of complete pension (100%) that can be received is exempt from tax and rest is taxed as salary.
- Without gratuity: Half of the extent of complete pension (100%) that can be received is exempt from tax and rest is taxed as salary.
Pension received by spouse, or children under the age of 25 years is taxable under the head "Income from Other Sources." While the commuted pension (lump sum received) will not be taxable, monthly payments are taxable to some extent- that is any amount beyond Rs 15,000 or one-third of the pension received (whichever is less). Pension received by the family members of the Armed Forces are completely exempt from tax.