Income tax returns 2024: Filing annual income tax returns are must for all Indian citizens. Employees while retiring have to pay taxes on pension, gratuity and employee provident fund. In India, employers provide various retirement benefits to employees. The most common retirement benefits offered by employers in India include pension, the Employee Provident Fund (EPF) and the National Pension System (NPS). These benefits are taxed under ‘Salaries’ as ‘profits in lieu of Salaries’ as specified in section 17. (3).
It is to be noted that the taxability of retirement benefits depends on certain factors, including the type of benefit, the amount received, and the individual’s tax status.
Here’s a basic guide on how retirement benefits are taxed
1. Pension and taxes
All retired employees, mostly senior citizens, earn pension. Pension is the one of most important retirement benefits available to Indians, mainly if he had a government job. Pension in India is either given as a lump sum amount or as a monthly allowance, or a combination of both.
Pension is a payment made by the employer after the retirement/death of the employee as a reward for past services. There are two kinds of pension:-
(a) Commuted Pension – Commutation of pension means immediate payment of the lumpsum amount to an employee in lieu of surrender of a portion of the monthly pension.
(b) Uncommuted Pension – When the pension is paid on a periodical basis, it is called an uncommuted Pension.
One should note that the taxation process is different for government and non-government employees. The lump sum amount received at the time of retirement, known as pension maturity, is fully exempted from taxes for government employees. On the other hand, non-government workers, who get a 100 per cent pension minus the gratuity amount, will pay tax on 50 per cent of the total amount. The remaining 50 per cent is exempted from income tax.
But if the private sector employee gets a 100 per cent pension including the gratuity, then one-third amount is exempted from tax and the rest is taxable.
On the other hand, the pension received as monthly income is taxed as usual salary as it is tagged as income.
2. Gratuity and taxes
For government employees, the gratuity amount they get at the time of retirement is fully exempted from taxation.
For non-government employees, there are two different ways of taxation. For those covered under The Payment of Gratuity Act, of 1972, the exemption is applied on the lowest amount of the following: Actual amount received as gratuity, 15 days salary* for each year working for the firm, or Rs 20 lakh. Here the salary in this case is the last drawn salary (of the employee) x Number of employment years x 15/26.
For those who are not under the ambit of the Payment of Gratuity Act, of 1972, the exemption applies to the lowest amount that is calculated as
Actual amount received as gratuity, half month salary* for each year working for the firm, or Rs 10 lakh. Here the salary is the average amount of the last 10 months’ salary.
The salary amount includes basic salary, dearness allowances, and performance-related incentives.
3. Provident Fund and taxes
Employee provident fund (EPF) amount is exempted from tax when if it is withdrawn after retirement. As per the Income-tax (IT) Act, the accumulated balance to the employee’s credit on the date of cessation of employment is exempted from tax.
If the employee has rendered continuous service with his employer (including previous employers if PF has been transferred) for a period of five years or more or if such continuous service (being less than five years) was terminated due to ill health or contraction or discontinuance of employer’s business or any other cause beyond the control of the employee, then it is exempted from tax.
However, the interest accrued on the accumulated balance, post retirement from employment (i.e., the period when no contribution is made to the EPF), is taxable, irrespective of your total contribution period with EPF.
4. Leave encashment benefits
In Union Budget 2023, leave encashment benefits received by the salaried class at retirement, whose limit was hiked from Rs 3 lakh to Rs 25 lakh, will be tax-free in their hands under the new income tax regime. They can switch to the new regime even in the year of retirement.
To file income tax returns (ITR) for retirement benefits, individuals should collect all relevant documents, such as pension statements and Form 16. They should then determine the amount of tax owed on their retirement benefits and file their ITR.
Retirement benefits also have several deductions and exemptions, which when applied can reduce the tax burden. For example, in the old tax regime, under Section 80C of the Income Tax Act, individuals can claim a deduction of up to Rs 1.5 lakh on their taxable income.