Retirement Benefits In Indian Tax system
Every employee must know the quantum of the various retirement benefits he would be getting, as well as its tax implications. The employee may get more benefits if he chooses a good employer but he has no choice in respect of taxes.
Retirement benefits received by an employee are taxable under the head Salary. Thus, the employer must take these benefits into account while computing the Tax Deducted at Source (TDS) at the time of retirement of an employee. Some retirement benefits are fully or partially exempt from tax.
Some of the retirement benefits are:
Pension
Pension is the income received by an employee after his retirement. It is a periodical allowance, on account of past service, given by a former employer after the retirement of an employee. Periodical pension is called un-commuted pension. When a lump-sum payment is made in lieu of a periodical pension, it is termed as commuted pension. Pension of an employee is taxable under the head salary. Taxability of pension depends on whether it is periodic or lump-sum.
Periodic payment (un-commuted pension) is fully taxable in case of both government and non-government employees.
Lump-sum Payment (commuted pension) is tax-free in case of government employees. In case of other employees, if that employee is also receiving gratuity, then 1/3rd of the commuted pension would be exempt from tax. If gratuity is not received by an employee, half of the commuted pension will be exempt from tax.
Gratuity
Gratuity is a lump-sum payment made by an employer as a mark of gratitude for the services rendered by his employee. It is an important form of social security benefit. Gratuity is payable at the end of the employment (by way of retirement, death, termination or resignation). Every employer who has more than 10 salaried workers is allowed to grant gratuity to workers. The law which governs gratuity in India is the Payment of Gratuity Act, 1972.
To receive gratuity, the employee should at least have completed 5 years of service. The payment of gratuity is made to the employee based on the duration of his total service to that employer. The benefit is payable by taking the last drawn salary as the basis for calculation.
For the purpose of Income Tax, gratuity received by an employee of the central government, state government or any local authority is completely exempt from tax. For other employees, the least of the following is exempt from tax –
- Rs. 10,00,000 (as per amendment from march 2010)
- Gratuity actually received, or
- Half month's average salary (average of last 10 months salary) for each completed year of service.
Leave Encashment
Leave encashment is the encashment of unused leave of an employee. The employee surrenders the leave at the time of retirement and is paid for the same. Taxability of leave encashment received at the time of retirement is as follows –
- In case of government employees, it is fully exempt from tax.
- In case of non-government employees, the least of the following is exempt –
- Rs. 3,00,000/-
- 10 months average salary
- Leave encashment actually received
- Cash equivalent to the leaves surrendered
Voluntary Retirement Compensation
Many companies today provide its employee with the option of taking voluntary retirement under the Voluntary Retirement Scheme (VRS). This scheme is drawn to right-size the existing strength of employees within a company. The benefits derived by an employee by opting VRS can also be considered as retirement benefit. VRS is applicable to only those employees who have completed 10 years of service or are of the age of 40 years. Under VRS, the employees are offered a onetime lump-sum amount. For income tax purposes, this compensation amount received is exempt up to Rs. 5,00,000/- if all the conditions under the scheme are fulfilled.
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