Tax on Retirement Benefits

The taxation of retirement benefits differs in the hands of central government employees, state government employees and private employees. Also, there are certain exemptions provided by the Government in case of retirement benefits.

Employees receive retirement benefits in various forms

Types of retirement benefits

1. Gratuity
2. Leave Encashment
3. Pension or Annuity
   1. Commuted pension
   2. Un-commuted pension
4. Voluntary Retirement Scheme (VRS)

1. Gratuity (Section 10(10))

Gratuity is a voluntary payment made by an employer in appreciation of the services provided by the employee.

1. Employees of Central Government/members of civil services/local authority employees: Any death cum retirement gratuity is fully exempt u/s 10(10)(i)
2. Other Employees (Non-Government)
1. Covered by Payment of Gratuity Act,1972: Any death cum retirement gratuity is exempt from tax to the extent of least of following
• Rs 20,00,000
• Actual Gratuity received
• 15 days salary based on last drawn salary for each completed year of service or part thereof in excess of 6 months

Note: No of days per month to be taken as 26 days

2. Not covered by Payment of Gratuity Act, 1972: Any death cum retirement gratuity is exempt from tax to the extent of least of following
• Rs 20,00,000
• Actual Gratuity received
• Half month’s Salary (based on last 10 months average salary immediately preceding the month of retirement or death) for each completed year of service

Note 1: Gratuity received during the period of service is taxable

Note 2: Gratuity is available to the employees who has completed 5 years of employment

2. Leave Encashment (Section 10(10AA))

Generally employees are allowed leaves during the period of service. Employees may avail such leaves or the leaves may either lapse or accumulated for future or allowed to be encashed every year or at the time of retirement/termination. The payment received on account of encashment of unutilized leave is called Leave Encashment.

1. Government Employees: Leave Encashment received at the time of retirement is fully exempt from tax
2. Non-Government Employees: Leave Encashment received is exempt from tax to the extent of least of following
• Rs 3,00,000
• Actual Leave encashment received
• 10 months average salary
• Period of earned leave In months ( Leave allowed-leaven taken/30 days) * 10 months average salary

Note: Leave Encashment received during the period of service is taxable.

3. Pension or Annuity

Pension is a periodic payment made by Government or a company or other employers to the employee in consideration of past service payable after his retirement

Pension is of 2 types i.e., Un commuted and Commuted Pension

1. Un commuted Pension: It means pension received periodically. It is fully taxable in the hands of both Government and Non-Government employees.
2. Commuted Pension: It means lumpsum amount taken by converting the future right to receive pension and receive the amount immediately
1. Employees of the Central Govt/local authorities/statutory corporation/members of civil services/defence services: Any commuted pension received is fully exempt from tax
2. Other employees: Any commuted pension received is exempt from tax in the following way
• If the employee is in the receipt of Gratuity, Exemption is 1/3*commuted pension received/commutation% *100%)
• If the employee is not in the receipt of Gratuity, Exemption is 1/2*commuted pension received/commutation% *100%)

4. Voluntary Retirement Scheme ( VRS )

Lumpsum Payment or otherwise received by an employee at the time of voluntary retirement is taxable.

Exemption of maximum Rs 5,00,000 is applicable only if the amount is received from the employers of Public sector company, any other company, local authority, cooperative society, IIT, State Government, Central Government.