SAVE RIGHT, RETIRE BRIGHT
When you are bidding good bye to your work life, the savings accumulated so far will be yours. The law grants tax exemptions on retirement benefits like PF, gratuity, superannuation and others. These benefits after retirement, which you have built over decades of disciplined savings, will be transferred to your bank account to help you enjoy retired life without any financial worries. 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.
On retirement, an employee normally receives certain retirement benefits. Such benefits are taxable under the head ‘Salaries’ as ‘profits in lieu of Salaries’ as provided in section 17(3). However, in respect of some of them, exemption from taxation is granted u/s 10 of the Income Tax Act, either wholly or partly. These exemptions are described below:-
- 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.
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 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 up to Rs 10 lakh tax free. Similarly, the clause of five years of service isn’t applicable to those who were disabled or dead.
- COMMUTATION OF PENSION
(i) In case of employees of Central & State Govt. Local Authority, Defenses Services and Corporation established under Central or State Acts, the entire commuted value of pension is exempt.
(ii) In case of any other employee, if the employee receives gratuity, the commuted value of 1/3 of the pension is exempt, otherwise, the commuted value of 1/2 of the pension is exempt.
- PAYMENT FROM APPROVED SUPERANNUATION FUND
Payment from an Approved Superannuation Fund will be exempt provided the payment is made in the circumstances specified in the section (Sec.10 (13)): death, retirement and incapacitation.
- LEAVE ENCASHMENT
(i) Leave Encashment during service is fully taxable in all cases; relief u/s 89(1) if applicable may be claimed for the same.
(ii) Any payment by way of leave encashment received by Central & State Govt. employees at the time of retirement in respect of the period of earned leave at credit is fully exempt.
(iii) In case of other employees, the exemption is to be limited to the least of following: (a) Cash equivalent of unutilized earned leave (earned leave entitlement cannot exceed 30 days for every year of actual service) (b) 10 months average salary (c) Leave encashment actually received. This is further subject to a limit of Rs.3, 00,000 for retirements after 02.04.1998.
(iv)Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of death is not taxable.
- RETRENCHMENT COMPENSATION
Retrenchment compensation received by a workman under the Industrial Disputes Act, 1947 or any other Act or Rules is exempt subject to following limits:-
(i) Compensation calculated @ fifteen days average pay for every completed year of continuous service or part thereof in excess of 6 months.
(ii) The above is further subject to an overall limit of Rs.5, 00,000 for retrenchment on or after 1.1.1997
- VOLUNTARY RETIREMENT SCHEME
Voluntary retirement can be opted by employees after completing 10 years of service or crossing the age of 40 years. The compensation paid by the company after an employee opts for VRS is exempt from tax up to Rs 5 lakh. Beyond that it is added to the income and taxed accordingly.
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.