Commuted value of the pension is a confusing topic for the retired and families receiving a pension. Commuted pension is usually a choice between present financial needs and future financial status. You should know how commuted value affects your pension before raising the demand.
Structured financial planning is essential for determining the commuted value of the pension. It will help you handle your present financial needs without hurting your future prospects.
You need to have enough money to live the rest of your life in comfort. Post-retirement, you will need:
a) Regular Cash Flow:To help you meet your daily and monthly expenses and let you live the same living standard.
b) Lump-Sum Amount:For your medical expenses, deal with life's uncertainties and meet your retirement goals.
Hence, you must plan your pension and know everything about it.
Commuted Pension - Definition
While you work, you and your employer contribute to the annuity fund that pays your pension when you retire. You have two options to receive the accumulated amount when you retire:
a) As a monthly pension
b) Lump-sum amount paid in advance
The advance amount you receive as lumpsum against your pension is called commuted pension. For example, at 60 years of age, you want to go on a vacation with your family. For that, you will need a lump sum amount.
You decide to receive 20% of your monthly pension of Rs 25,000 in advance for the next five years’ worth. The amount will be paid to you as a lump sum and will be calculated as:
20% of 25000*12*5 = Rs 3,00,000.
This amount is your commuted pension.
You can commute pension at retirement or during the retirement years. You can commute pension multiple times also.
Retirement and Death Gratuity
The Payment of Gratuity Act 1972, applies to any establishment employing 10 or more employees or workers. The Act holds such firms to provide gratuity payments to the eligible employees upon retirement or death.
1. Retirement Gratuity
You are eligible to receive retirement gratuity when you voluntarily leave the service or retire. The eligibility criteria also include a minimum of five years of service with the organization. The gratuity will be equal to:
i. 1/4th of Basic + DA as on the date of retirement for each completed six-monthly period of service.
ii. Maximum gratuity for government servants is limited to Rs 20 lakhs.
iii. There is no maximum limit for gratuity payment to employees of a private company. But the excess amount can be taxable.
2. Death Gratuity
Organizations providing gratuity benefits to their employees can pay gratuity amounts upon the death of an employee on duty. This is regardless of the length of the duty of the employee.
Death gratuity benefits from private employers depend on the gratuity plan opted by them. However, in any case, the minimum benefit from the plan will be as defined for government employees.
Death gratuity benefits for the family of government employees are as follows:
|Qualifying Service||Gratuity Amount|
|Up to 1 year||2x basic pay|
|1 year to less than 5 years||6x basic pay|
|5 years to less than 11 years||12x basic pay|
|11 years to less than 20 years||20x basic pay|
|20 years or more||Lower of the following:
- Half of the emoluments for every completed 6 monthly periods of qualifying service
- 33x of emoluments
Is Commuted Pension Taxable?
The taxability of commuted pension varies depending on your job category - government or non-government employee. The taxability for commuted pension works as below:
|Government Employee||Non-Government Employee|
|For a government employee, the commuted pension is 100% tax exempted. You do not have to pay any tax.||For a non-government employee, there are two situations:
Learn how to build a tax-free pension income for retirement.
Do you Need to File ITR for Commuted Pension?
You will have to file ITR for the commuted pension you receive, and if it is higher than the limits allowed. The excess pension amount you receive in the given assessment year is fully taxable. You have certain tax relief under Section 89 of the Income Tax Act. However, to claim the benefits under Section 89, you need to file Form 10E.
You will have to report your commuted income while filing income tax returns. Follow the below steps to show your pension:
a) Under the salary schedule in the ITS, select the 'Pensioner' option in the field 'Nature of Employment'.
b) If you have received a pension as a salary, you will need to provide your employer's name, TAN, and address.
c) The part of income that is tax-exempt should be reported as a Commuted Pension. The remaining should come under 'Salary u/s 17(1)' as 'Annuity Pension'.
What if you Receive a Pension as a Family Member?
The taxation rules are different if the pension is received by a family member. Your income, in this case, is taxed under ‘Income from other sources’ in a family member's ITR. Below are the rules:
a) Pension received by family members of armed forces employees or UNO employees is tax-exempt.
b) Uncommuted pension received by an employee's family members is tax-exempt for up to one-third of the pension amount or Rs 15,000 in a given financial year (lower of the two).
For example, if a family member receives a pension of Rs 1.2 lakh in a financial year, the exemption available will be lower of two (Rs 15,000 or 1/3 of 1,20,000). Hence, your taxable income will be Rs 1.05 lakh.
Claiming Tax Exemptions on Commuted Pension
Pensioners can claim a deduction under Section 80C up to Rs 1.5 lakh from their gross total income. Although after 60 you can claim up to Rs 2 lakh under a few heads, most eligible expenses and investments allow up to Rs 1.5 lakhs only. Below are some investment options to avail of tax exemption:
a) Equity Linked Saving Scheme (ELSS):You can invest in ELSS for higher returns. It comes with a lock-in of 3 years, and your investment gets exemption under Section 80C up to Rs 1.5 lakh.
b) Fixed Deposits:You can invest in tax-saving fixed deposits. It comes with a lock-in of 5 years. If you are over 60 years, most banks will give you an additional interest on the fixed deposits account.
c) Unit Linked Insurance Plan (ULIP):This plan gives you dual benefits of insurance and investment options. A part of your investment goes towards insurance and the balance towards the investment bucket. The investment you make in a financial year (premium) is eligible for a tax deduction.
d) Pension Plan Investments:Even the pension plans from life insurance companies are eligible for an 80C deduction on the invested money.
e) National Savings Certificates (NSC):NSC is also one of the safe investments allowing you to claim a deduction at the time of investment. The accrued interest, however, will be taxable five years later.
f) Senior Citizens Savings Scheme:This is another great way to convert your taxable commuted pension into a tax-free amount. At the same time, you will also receive interest as cash flow from the deposit.
Learn more about Senior Citizens Savings Scheme.
Thus, if you can plan for about three to five years, you can convert taxable commuted pension to tax-free at a rate of Rs 1.5 lakhs a year.
You can use a commuted pension to fulfil your retirement goals. The monthly pension you receive from your retirement savings is fully taxable. However, if you are just starting your retirement investments you can use online ULIP plans like Invest 4G to build a tax-free pension after 60.
Invest 4G is a ULIP plan from Canara HSBC Bank of Commerce life insurance and allows a holding period of up to 99 years of age. This means you can build a corpus from 30 to 60 or 65 and draw a tax-free lifetime pension after that. Additionally, upon your natural demise, the plan will pay higher of the sum assured or fund value to your nominees. Thus, fulfilling another life goal for you – legacy.
You should only commute as much as you need to meet your retirement goals. It is equally important that you receive a decent monthly income to maintain the same living standards. With the above information, you know how commuted income is taxed and what is the tax exemption. You should take care of your commutation limits.Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard.