Pension plans have a big role to play once we cross the age of 60 - they provide financial coverage and give us a sense of financial stability and security. Now, it must be noted that just because we’ve retired, we don’t just stop paying taxes. The pension that a retired individual receives is regarded as salary and is therefore taxed as ‘income from salary’.
To understand how taxes are calculated on pensions, let us first look at the two kinds of pensions:
|Commuted pension||Uncommuted pension|
|An individual, upon retirement, has the option to withdraw a percentage of the pension benefits in lump-sum. The amount received in lump-sum is considered as commuted pension.||Uncommuted pension refers to the pension that a retired individual receives on a periodic basis. The amount received as uncommuted pension is fully taxable in the hands of the retired individual.|
Consider the following example to better understand how commuted and uncommuted pensions work:
Mr. X’s monthly pension amounts to Rs. 20,000. Due to immediate requirement of funds, Mr. X opts to take 10% of 10 years’ pension in lump-sum. By doing so, he receives a commuted pension of Rs. 2,40,000 (10% of 20,000 multipled by 120). For the 10-year period, Mr. X will receive Rs. 18,000 in uncommuted pension each month and post that he stands to receive Rs. 20,000 on a monthly basis.
Tax on pension
The income received in the form of pension is taxable under Section 192 of the Income Tax Act.
Commuted pension is exempt from tax in certain cases. Government employees do not have to incur tax on commuted pension. For non-government employees, however, it is partially exempt. In case you receive gratuity with pension, 33.33% of the pension sum that would have been received if the entire 100% of pension was commuted is tax exempt. If you only receive pension then 50% of the pension sum, which would've been received if the whole pension was commuted, is tax exempt. Under uncommuted pension, the family pension that is received comes under ‘income from other sources’. An amount that is equal to 1/3rd of the pension sum or Rs. 15,000, whichever is lesser, is tax exempt.
For employees of the armed forces, the pension or family pension amount received is completely exempt from tax.
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