Pension is a retirement benefit, received by the employee on a regular basis, after retirement, if his employment terms so provide. Usually, pension is paid out on a monthly basis, he/she may also choose to take pension as a lump sum (also called commuted pension) instead of a periodical payment. It is taxed under the head ‘income from salary’ in his/her income tax return.
Let us understand commuted pension with the help of an example.
Suppose, At the age of 60, X decides to receive 60% of his monthly pension of ₹20,000 of the next 10 years in advance, which will be paid to him as a lump-sum. Therefore, X will receive ₹14,40,000 (60% of 20,000*10*12) as commuted pension.
X will continue to receive ₹8,000, on monthly basis for the next 10 years i.e. until you are 70 years of age, referred to as uncommuted pension. After that, you will be paid your full pension of ₹20,000 every month.
Pension is taxed in the following manner:
- Commuted Pension: if received by:
- Government employee: it is fully exempt from tax.in other words, no tax will be charged on the pension received from the government.
- Non- Government employee: it is partially exempt from tax.
- If gratuity is also received: 1/3rd of the amount of pension which the employee would have received, if he had commuted 100% of the pension is exempt from tax and remaining is taxed as salary. In the above case, if X had commuted 100% of the pension he would have received ₹24,00,000 (14,40,000*100/60). Therefore, ₹8,00,000 (24,00,000/3) would be exempt from tax out of the commuted pension of ₹14,40,000. It is assumed that X has received gratuity also.
- If gratuity is not received: 1/2 of the amount of pension which the employee would have received, if he had commuted 100% of the pension is exempt from tax and remaining is taxed as salary. In the above case, if X had commuted 100% of the pension he would have received ₹24,00,000 (14,40,000*100/60). Therefore, ₹12,00,000 (24,00,000/2) would be exempt from tax out of the commuted pension of ₹14,40,000. It is assumed that X didn’t receive any gratuity.
- Uncommuted Pension: it is fully taxable as salary. In the above case, ₹8,000 received by X on monthly basis is fully taxable. ₹20,000 starting the age of 70 years are fully taxable as well.
Important points to note:
- If commuted pension is being received by the family members after the death of the employee, no tax will be deducted. But uncommuted family pension is taxable under the head ‘Income from other sources’. Although, it is exempt from tax up to ₹15,000 or 1/3rd of the uncommuted pension received, whichever is less.
- Pension that is received from UNO by its employees or their family or by the family members of Armed Forces is exempt from tax.
- ½ of the commuted pension received by judges of Supreme Court and High Court is also exempt from tax.