Tax on retirement benefits

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: Retirement benefits are offered to employees to ensure an independent life and maintenance of the standard of living even after their retirement. Different companies formulate different plans of compensating their employees. Contributions to some of the funds may be mandatory due to statutory provisions, whereas few other plans may be voluntary. The existence of a remunerative retirement benefit plan not only boosts the motivation level of the employees to perform at their best, it also helps the employers in attracting and retaining the talent. There are several types of retirement benefits such as gratuity, pension, superannuation, provident fund, etc.

The taxability of retirement benefits need to be examined at two stages, i.e. one at the time of contribution by the employer and other at the time of payment to employee on retirement.

Generally, during the course of employment, the employer contributes to certain funds like superannuation fund, provident fund, gratuity fund, etc for payment in the year of retirement to the eligible employees. The employer's contribution to approved superannuation fund, recognised provident fund and gratuity fund are considered tax exempt in the hands of the employee in the year of contribution. Though, the employer is required to pay FBT on the contributions made to the approved superannuation fund for the employees [contribution in respect of each employee in excess of Rs 1 lakh].

On the one hand, the employers' contribution to recognized provident fund is not taxable in the hands of the employee, the employee is also eligible to claim deduction from total income under section 80C of the Income Tax Act in respect his/her own contribution to such fund up to a maximum of Rs 1 lakh. [Certain other payments/investments are also eligible for such deduction within this overall limit].

At the time of retirement, the taxability of receipts generally depends upon the type of retirement benefit and the mode of payment. Though regular monthly pension is taxable in full in the hands of the employee, the tax exemption may be claimed for several one time payments like gratuity, leave encashment, commuted pension etc, based on the prescribed formulas under the Income Tax Act.