Taxation of Retirement Benefits: H&R Block

H&R BLOCK – How are my post-retirement benefits taxed?

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H&R BLOCK – How are my post-retirement benefits taxed?

 

Saving optionTaxability of IncomeTax free limitsTax free if ...
EPFNilNo limitRecognised provident fund. Service of min 5 yrs
GratuityNil upto limitRs 10 lakhNA
Leave EncashmentNil for government employee, otherwise taxed after limitsLeast of 10 months salary or Rs 3 lakhPaid to heirs upon employee’s death
SuperannuationExempt for govt employees, for others taxed beyond limits1/3 of fund for those who get gratuity and ½ of fund for othersIf annuity purchased from life insurer with balance
VRS (Voluntary Retirement Scheme)Taxed as salary beyond limitLowest of (3 months last salary) x (Work Years) or Rs 5 lakhNA
BonusTaxed as incomeFully Taxable
Ex-gratiaTaxable as incomeNilPaid to family on injury or death of employee
New Pension SchemeTaxed at maturityNilNA

When you are bidding your work life a good bye, the savings accumulated will finally be yours. But before you get excited about the enormous sum to be used for the sunset years consider the taxability on various retirement benefits handed out.

The elderly try hard to push the tax axe from snipping the shrinking purse for retirement years. But it is heartening to see a substantial portion of retirement benefits, accumulated after years of diligent service, being swallowed by taxes.

Government employees would be smiling their way to the bank upon receiving, but private sector employee often frown as they are given a step motherly treatment, when it comes to taxes on departing benefits.

Government employees are blessed with tax exemptions on benefits such as commuted pension (received as lumpsum), gratuity and leave encashment. However, private sector employees need to cough up tax as per the rules. Here are some of the rules that govern your retirement benefits. There are means to reduce the tax outgo too.

Provident fund: 

The amount one receives from provident fund – statutory provident fund and employee’s provident fund (EPF) – is completely exempt, provided your employer investing it in a recognized provident fund. Taxes are applicable, however, on the employer’s contribution to PF and the interest credited to such fund.

There are circumstances under which the EPF corpus along with interest would be taxed. If your employer has been contributing more than 12% of your salary to EPF then the proceeds of EPF would be taxed. Also, any interest paid more than 9.5% per annum is added to the income and taxed.

There are restrictions in case of number of years one should serve to claim the tax benefit. If an employee hasn’t completed 5 years of continuous service with an employer then the EPF corpus is taxable. In such a situation one should transfer the amount to the new EPF account or convert your EPF account to a universal account and reclaim the tax free status.

Gratuity:

This lump-sum payment offered to long-term employees is exempt from tax only for government employees. But private sector employees receiving gratuity in excess of Rs 10 lakh (enhanced from Rs 3.5 lakh earlier) would attract tax.

The rules are a tad different for those who are covered under the Payment of Gratuity Act. The least of either the 15 days of last drawn salary for each working year, the actual gratuity received or Rs 10 lakh.

But the salary for the 15 days is worked out in a special way. Last drawn monthly salary is divided by 26 (maximum working days in a month). Salary considered for the purpose includes dearness allowance but excludes bonus, commission, house rent allowance, overtime wages and other allowances.

Though payment of gratuity for employees covered under the Payment of Gratuity Act, is fully taxable for an employee who hasn’t completed five years, there are situations where this rule can be overridden. Employees who are not covered under the Act do not have to fulfill 5 years of service to get gratuity upto Rs 10 lakh tax free. Similarly, the clause of five years of service isn’t applicable to those who were disabled or dead. 

Superannuation Fund: 

Amount received under superannuation is exempt if it is paid upon death, retirement, in lieu of or as annuity. Any commutation of pension is exempt up to one-third of the commuted value of pension where the employee receives any gratuity. In other cases it is exempt upto half of the commuted value.

Interest accumulated on the superannuation fund too is spared from taxes. These taxation benefits are overturned if the amount is received by an employee who resigns. TDS is deducted at the average rate of tax applicable during the preceding three years or during the membership period, if less than three years.

Purchasing SAF-related annuity without any commutation can help you escape tax. The balance amount of the commuted value is exempt if annuities are purchased from life insurance companies only.

Leave Encashment:

State and Central governments receive leave encashment tax free without any limits. But the treatment of leave encashment for others depends on whether the benefit is claimed at the time of retirement or during continuance of service.

Leave encashment during the continuity of employment is chargeable to tax, while at the time of retirement/ leaving job is fully exempt from tax subject to conditions.

The Income Tax Act specifies three conditions based on which the lowest possible amount paid as leave encashment is exempt from taxes. However, even if calculated by those methods any amount above Rs 3 lakh is not exempt as leave encashment.

The amount of leave encashment which is taxable would be added to the salary and taxed as per normal slab rate applicable to the employee.

Voluntary Retirement Scheme:

Voluntary retirement can be opted by employees after completing 10 years of service or crossing the age of 40 years. Another condition applied is that the post held should be left vacant afterwards.

The compensation paid by the company after an employee opts for VRS is exempt from tax upto Rs 5 lakh. Beyond that it is added to the income and taxed accordingly.

There are ways to avoid getting into a higher income tax bracket because of hefty compensation paid for the year of retirement. This exemption is also available even if the VRS amount is paid in installments spread over different years. Staggering this amount would mean that he/she does not have to suffer the entire tax upfront but is subjected to TDS as and when the installments are paid.

Moreover, the employee would also benefit from interest payable on the outstanding VRS amount at a rate much higher than the market rate and from a very safe source – his erstwhile employer.

New Pension Scheme: 

Central and state government employees who joined in January 2004 get pension via the New Pension Scheme. Though they will get tax benefit when they invest in this scheme, the amount they receive at maturity from this scheme will be taxed.

Other payments:  

Companies also offer some meritorious employees a parting bonus or ex-gratia to lend a golden hand shake. However this amount is fully taxable, without any exemption limits.

Now that you know the taxation rules governing your retirement benefits plan ahead of time to save taxes and protect the income for your sunset years.

H&R Block India strives to blend tax expertise with a strong focus on continually improving the client experience to provide all its clients with an unparalleled value proposition for E filing their Income Tax Returns Online.

 Visit hrblock.in for more information or to find your nearest office to find assistance to file taxes.

HRBlockIndia
HRBlockIndia
H&R Block India strives to blend tax expertise with a strong focus on continually improving the client experience to provide all its clients with an unparalleled value proposition for filing their Income Tax Online.

4 Comments

  1. TATAVARTY VISWANADHA RAO says:

    In which schedule of ITR 1 & 2 the exempted retirement benefits like gratuity, leave encashment, comutation are to be shown

  2. kishore says:

    I served in a private Ltd Company for appx 9 months and company paid Rs 15000 as ex gratia Gratuity and appx 7 thousands as leave encashment. I am a ex BSF and received Appx 6 lacs as gratuity and appx 4 lacs as leave encashment from central govt. weather this amount ( ex gratia gratuity) is taxable or not.

  3. Amit says:

    Hello,

    As a Non Resident, will I still have to pay income tax on the 1/3 Commuted Value of the Superannuation Fund. I have received Gratuity too.

    Thnx.

    • HRBlockIndia HRBlockIndia says:

      Whether be a resident or non – resident there is a process to calculate the exempt value of the commuted pension. You would be liable to pay the taxes on the remaining income.
      There is also a provision for calculating the taxable gratuity.

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