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ITR Filing: How Are Retirement Benefits Taxed? 4 Rules That You Should Know

Non-government employees will have to pay tax on 50 per cent of the lump sum amount drawn at retirement minus the gratuity; the remaining portion is tax-free.

July 8, 2024
July 8, 2024
Tax refund

Tax refund

The income tax department has rules for taxing various retirement benefits, including monthly pensions, lump sum payouts, leave encashment, gratuity, and income from provident fund, etc.

Hence, it is critical for you to understand these rules before filing an income tax return (ITR).

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Also Read: Employees Provident Fund: When Can You Withdraw Funds From Your EPF Account?

Here are a few scenarios when your retirement benefits could be taxed.

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Pension Income

Tax rules and benefits may vary depending on where the person is engaged, whether in government, non-government, corporate, or unorganised sectors. The pension calculation may also differ depending on the receivables at retirement. For instance, a government employee may opt for a lump sum payment at retirement. In that case, they would forgo a part of their monthly pensions. Likewise, they may opt for a monthly pension instead of the additional lump sum benefit they are entitled to. If they choose the former, the entire lump sum at maturity is tax-free.

On the other hand, non-government employees will have to pay tax on 50 per cent of the lump sum amount drawn at retirement minus the gratuity; the remaining portion is tax-free. Similarly, private-sector employees receive a different tax treatment—one-third of the amount is exempt, and the remaining two-thirds is taxed. Pension received as monthly income is taxed as salary and is applied based on the income slab.

Gratuity Payments

The gratuity amount paid to a government employee at retirement is tax-exempt. Non-government employees covered under the Gratuity Act, 1972, are entitled to tax relief based on a formula with a limit of up to Rs 20 lakh, while those not covered under the Act also get tax relief up to Rs 10 lakh.

Also Read: ITR Filing: How Can You Save Capital Gain Tax On Your Equity Investments?

Employees’ Provident Fund

The maturity amount of the Employees Provident Fund (EPF) is tax-exempt as per the Income Tax Act. Furthermore, the accumulated balance at the time of cessation of employment if the employee has served for five years or more or if the job was terminated due to ill health, contraction, or discontinuance of business is exempt from tax. However, any interest earned on the accumulated balance post-retirement is taxable.

Leave Encashment

In the Union Budget 2023, the government increased the tax limit for leave encashment at retirement from Rs 3 lakh to Rs 25 lakh, making it tax-free for most salaried people. It also allowed taxpayers to switch to the new tax regime even in their retirement year, offering them more flexibility in financial and tax planning.

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