Retirement benefits form a critical part of your post-employment financial planning. These benefits, while received at the end of your service, often have tax implications that vary depending on the type of benefit and your employment status (government or private sector). Here’s how various retirement benefits are treated under the Income Tax Act:
1. Leave Encashment
What is it?
Leave encashment is the amount received for unused earned leave at the time of retirement or resignation. It is treated as part of your salary income.
Tax Treatment:
If leave encashment is received from multiple employers, the combined exemption cannot exceed ₹25,00,000. This rule applies under both old and new tax regimes.
2. Relief on Salary Arrears or Advance (Section 89(1))
When you receive salary in arrears or in advance, it may push you into a higher tax bracket. Section 89(1) provides tax relief to mitigate this additional burden.
Relief Calculation Steps:
Calculate tax on total income including arrears/advance.
Calculate tax on income excluding arrears/advance.
Find the difference (Step 1 – Step 2).
Calculate tax for the year(s) to which the arrears relate — both with and without the arrears.
Find the difference (Step 4 – Step 5).
If Step 3 > Step 5, the excess is the relief under Section 89(1).
Relief is only applicable if there is a genuine increase in tax liability due to receipt of past dues in a lump sum.
3. Voluntary Retirement Compensation (Section 10(10C))
If you opt for Voluntary Retirement (VRS), the compensation you receive may be eligible for exemption under Section 10(10C).
Key Points:
Maximum exemption: ₹5,00,000
Applicability: Once in a lifetime, only in the year received
Eligible employees: Central/State Government employees, PSUs, local authorities, universities, notified institutions
Condition: VRS scheme must comply with Rule 2BA of the Income Tax Rules
You cannot claim both this exemption and Section 89 relief for the same compensation.
4. Pension: Commuted and Uncommuted
Uncommuted Pension (regular monthly payments):
Commuted Pension (lump-sum):
5. Family Pension
Pension received by a deceased employee’s family member is taxed under “Income from Other Sources”.
Tax Treatment:
Monthly pension: Exemption up to ₹15,000 or 1/3rd of the pension, whichever is lower
Lump-sum family pension: Fully exempt
Armed forces or UN pension: Fully exempt for family members
Under the new tax regime: A deduction of 1/3rd of the pension received is allowed, up to ₹25,000.
6. Gratuity
Gratuity is a lump-sum benefit given by an employer upon retirement or resignation after at least five years of continuous service.
For Government Employees:
For Non-Government Employees:
Tax exemption depends on whether the employer is covered under the Payment of Gratuity Act:
If Covered under the Act:
Exempt amount is the least of:
15 days’ salary for each completed year of service (more than 6 months = full year)
₹20,00,000 (maximum exemption limit)
Actual gratuity received
If Not Covered under the Act:
Exempt amount is the least of:
½ month’s average salary (last 10 months) per completed year of service
₹20,00,000 (maximum exemption limit)
Actual gratuity received
Example: If you’ve worked for 14 years and 9 months, it counts as 14 years. Salary is calculated based on the average of the last 10 months before retirement.
Summary Table: Taxability of Key Retirement Benefits
Benefit | Taxability |
|---|
Leave Encashment (Govt) | Fully exempt |
Leave Encashment (Private) | Exempt up to ₹25,00,000 based on conditions |
Arrears/Advance Salary | Relief available under Section 89(1) |
VRS Compensation | Exempt up to ₹5,00,000 under Section 10(10C), once in a lifetime |
Uncommuted Pension | Fully taxable |
Commuted Pension (Govt) | Fully exempt |
Commuted Pension (Private) | Partially exempt based on gratuity receipt |
Family Pension | Partially exempt under “Other Sources”; fully exempt for armed forces/UN cases |
Gratuity (Govt) | Fully exempt |
Gratuity (Private) | Exempt up to ₹20,00,000, subject to eligibility and conditions |
