Tax on Pension Income: Computation of Amount Exempted

In most cases, employees are paid a certain amount in lieu of the services provided by him or her to their respective employers, upon retirement. This amount is paid periodically and is referred to as pension.

In order to maximize the amount of pension received by an employee, the Government of India recently launched NPS or National Pension Scheme. Under this scheme, an employee is paid a certain periodic amount in addition to the pension amount paid by their employers. This is a brilliant scheme available for all salaried professionals looking to ensure a regular income after their retirement. Furthermore, the income tax authorities allow a tax deduction on National Pension Scheme under the Section 80CCC and Section 80CCD of the Indian Income Tax Act.

Remember, the pension amount that you receive from your employer or pension fund received from other sources is taxable. Sadly, a large fraction of salaried people find it difficult to compute and calculate the income tax liability on their pension fund or income. And that is why, in this article, we have explained how to calculate income tax on pension income availed by a salaried professional upon retirement.

So, let’s get started! Shall we?

But before we jump guns and get into the nitty-gritties of calculating the income tax liability on pension income, it only makes sense to understand the two different types of Pension incomes.

Uncommuted and Commuted Pensions

These 2 distinct pension incomes – Uncommuted and Commuted pensions.

Here is a detailed explanation for both of them:

1. Uncommuted Pension: It refers to the pension amount that is received by an employee periodically upon retirement. Any uncommuted pension amount received by an employee upon retirement is liable to be taxed in full. And this remains same for both government and non-government employees. This means an employee needs to pay income tax on uncommuted pension, no matter whether you have worked as a government employee or a private sector employee, in the past.
2. Commuted Pension: Commuted pension is the part of pension amount that one receives in a lump-sum. Let us explain this in greater details. Many a times, employers allow their employees to surrender a part of their pension income and later receive that income in a lump-sum. This amount received by the employee is referred to as the Commuted Pension. It is allowed to choose one’s pension to be fully or partly commuted.

Let’s take an example to understand commuted pension clearly. Let’s suppose Amit is liable to get a monthly pension income of Rs. 2000, upon retirement for the rest of his life. Here, he may choose to partially commute 25% of his pension income in order to receive a lump-sum payment of Rs. 30,000, upon a stipulated period of time. It is important to note here that Amit’s pension amount will be 75% of his monthly pension income, i.e., 75% of Rs. 2000, which comes out to be Rs. 1500 per month.

Calculation of Income Tax Liability on Commuted Pension

It is really easy to calculate the income tax liability on the commuted pension. Here is how to calculate the income tax liability on the Commuted Pension under the Section 10 (10A) of the Income Tax Act that you need to ensure at the time of filing income tax returns.

Let’s suppose:

An employee receives X amount as Commuted Pension. So, this amount will be subtracted from amount of tax exemption allowed. The amount that you get after subtracting the two will be the total tax liability to be paid by the employee.

Here’s how to calculate the exemptions on Pension amount:

1. For Government Employees: There is no income tax on government employees. This means that their pension, which they receive from government offices, is absolutely tax free.
2. For Non-Government Employees: The pension amount received by a non-government employee is taxable. However, there are a certain exemptions allowed on the Pension Income.

Income Tax on Income Received as Pension

The pension received by an employee upon retirement is taxable as the income received in ‘Salary’. However, if the uncommuted pension is received by the nominee of the employee, in the event of the demise of the employee, the pension income received is taxable as “Income from Other Sources.” This is because after the death of the employee, the employee-employer relationship ceases to exist. In the event of the demise of the employee and the uncommuted pension income being received by the nominee of the employee, one third of the pension amount or Rs.15000, whichever is the two is a lower amount is tax exempted. For Commuted Pension being paid to the nominee or the family member, in the event of the demise of the employee, no tax is required to be paid on the income.

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