Taxability of Retirement Benefits

Retirements benefits are a component of the salary compensation, intended to secure the financial future of employees post retirement. Pension and gratuity are the most popular retirement benefits in India. Both are payments rendered by employers to the employees for past services rendered by them. The only difference is that pension is offered to permanent employees, while gratuity is typically offered to individuals employed on contract terms.

Taxability of Gratuity

Gratuity may be received by the employee himself at the time of retirement or may be received by the legal heir of the employee on the event of his death. For the purpose of computing taxability of gratuity, employees are classified into three categories:

Government employees and employees of local authorities: In this case the entire funds received as gratuity are tax exempt.

Employees covered under the Payment of Gratuity Act, 1972: For employees covered under this act, the minimum amount of the following is tax exempt:

• The actual amount of gratuity received
• 15 days’ salary for each completed year of service. If an individual is employed in a seasonal establishment or is not employed throughout the year, the exemption is lowered to 7 days wages for each season.
• Rs.3,50,000

Other Employees: For a non-government employee who is not covered under the Payment of Gratuity Act, the exemption is the lowest of the following:

• Actual gratuity received
• Half month’s average salary for each completed year of service
• Rs.3,50,000

Treatment of Pension under Income Tax Act, 1961

Pension is typically offered as a lump-sum on retirement. However, some employers pay pension periodically, generally on a monthly basis with the salary. The former is known as commuted pension, while the later is called uncommuted pension. Commuted pension is fully tax exempt for government employees. For other employees, an exemption of one-third of the total commuted pension is applicable, when receiving gratuity and half of the total value when not receiving any gratuity. Note that uncommuted pension is fully taxable in the hands of government as well as private employees.