Commuted Pension: What is Commuted Value of Pension and Its Taxability? (2023)

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Commuted value of the pension is a confusing topic for the retired and families receiving a pension. Commuted pension is usually a choice between present financial needs and future financial status. You should know how commuted value affects your pension before raising the demand.

Structured financial planning is essential for determining the commuted value of the pension. It will help you handle your present financial needs without hurting your future prospects.

You need to have enough money to live the rest of your life in comfort. Post-retirement, you will need:

a) Regular Cash Flow:

To help you meet your daily and monthly expenses and let you live the same living standard.

b) Lump-Sum Amount:

For your medical expenses, deal with life's uncertainties and meet your retirement goals.

Hence, you must plan your pension and know everything about it.

Commuted Pension - Definition

While you work, you and your employer contribute to the annuity fund that pays your pension when you retire. You have two options to receive the accumulated amount when you retire:

a) As a monthly pension
b) Lump-sum amount paid in advance

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The advance amount you receive as lumpsum against your pension is called commuted pension. For example, at 60 years of age, you want to go on a vacation with your family. For that, you will need a lump sum amount.

You decide to receive 20% of your monthly pension of Rs 25,000 in advance for the next five years’ worth. The amount will be paid to you as a lump sum and will be calculated as:

20% of 25000*12*5 = Rs 3,00,000.

This amount is your commuted pension.

You can commute pension at retirement or during the retirement years. You can commute pension multiple times also.

Retirement and Death Gratuity

The Payment of Gratuity Act 1972, applies to any establishment employing 10 or more employees or workers. The Act holds such firms to provide gratuity payments to the eligible employees upon retirement or death.

1.Retirement Gratuity

You are eligible to receive retirement gratuity when you voluntarily leave the service or retire. The eligibility criteria also include a minimum of five years of service with the organization. The gratuity will be equal to:

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i. 1/4th of Basic + DA as on the date of retirement for each completed six-monthly period of service.
ii. Maximum gratuity for government servants is limited to Rs 20 lakhs.
iii. There is no maximum limit for gratuity payment to employees of a private company. But the excess amount can be taxable.

2.Death Gratuity

Organizations providing gratuity benefits to their employees can pay gratuity amounts upon the death of an employee on duty. This is regardless of the length of the duty of the employee.

Death gratuity benefits from private employers depend on the gratuity plan opted by them. However, in any case, the minimum benefit from the plan will be as defined for government employees.

Death gratuity benefits for the family of government employees are as follows:

Qualifying Service Gratuity Amount
Up to 1 year 2x basic pay
1 year to less than 5 years 6x basic pay
5 years to less than 11 years 12x basic pay
11 years to less than 20 years 20x basic pay
20 years or more Lower of the following:

-Half of the emoluments for every completed 6 monthly periods of qualifying service
-33x of emoluments

Is Commuted Pension Taxable?

The taxability of commuted pension varies depending on your job category - government or non-government employee. The taxability for commuted pension works as below:

Government Employee Non-Government Employee
For a government employee, the commuted pension is 100% tax exempted. You do not have to pay any tax. For a non-government employee, there are two situations:
  • Pension received along with gratuity: One-third of the commuted pension is exempted from tax while the remaining two-thirds will be taxed like salary when received.
  • Pension received without gratuity: 50% of your commuted pension is exempted from income tax.
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Learn how to build a tax-free pension income for retirement.

Do you Need to File ITR for Commuted Pension?

You will have to file ITR for the commuted pension you receive, and if it is higher than the limits allowed. The excess pension amount you receive in the given assessment year is fully taxable. You have certain tax relief under Section 89 of the Income Tax Act. However, to claim the benefits under Section 89, you need to file Form 10E.

You will have to report your commuted income while filing income tax returns. Follow the below steps to show your pension:

a) Under the salary schedule in the ITS, select the 'Pensioner' option in the field 'Nature of Employment'.
b) If you have received a pension as a salary, you will need to provide your employer's name, TAN, and address.
c) The part of income that is tax-exempt should be reported as a Commuted Pension. The remaining should come under 'Salary u/s 17(1)' as 'Annuity Pension'.

What if you Receive a Pension as a Family Member?

The taxation rules are different if the pension is received by a family member. Your income, in this case, is taxed under ‘Income from other sources’ in a family member's ITR. Below are the rules:

a) Pension received by family members of armed forces employees or UNO employees is tax-exempt.
b) Uncommuted pension received by an employee's family members is tax-exempt for up to one-third of the pension amount or Rs 15,000 in a given financial year (lower of the two).

For example, if a family member receives a pension of Rs 1.2 lakh in a financial year, the exemption available will be lower of two (Rs 15,000 or 1/3 of 1,20,000). Hence, your taxable income will be Rs 1.05 lakh.

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Claiming Tax Exemptions on Commuted Pension

Pensioners can claim a deduction under Section 80C up to Rs 1.5 lakh from their gross total income. Although after 60 you can claim up to Rs 2 lakh under a few heads, most eligible expenses and investments allow up to Rs 1.5 lakhs only. Below are some investment options to avail of tax exemption:

a) Equity Linked Saving Scheme (ELSS):

You can invest in ELSS for higher returns. It comes with a lock-in of 3 years, and your investment gets exemption under Section 80C up to Rs 1.5 lakh.

b) Fixed Deposits:

You can invest in tax-saving fixed deposits. It comes with a lock-in of 5 years. If you are over 60 years, most banks will give you an additional interest on the fixed deposits account.

c) Unit Linked Insurance Plan (ULIP):

This plan gives you dual benefits of insurance and investment options. A part of your investment goes towards insurance and the balance towards the investment bucket. The investment you make in a financial year (premium) is eligible for a tax deduction.

d) Pension Plan Investments:

Even the pension plans from life insurance companies are eligible for an 80C deduction on the invested money.

e) National Savings Certificates (NSC):

NSC is also one of the safe investments allowing you to claim a deduction at the time of investment. The accrued interest, however, will be taxable five years later.

Commuted Pension: What is Commuted Value of Pension and Its Taxability? (4)

f) Senior Citizens Savings Scheme:

This is another great way to convert your taxable commuted pension into a tax-free amount. At the same time, you will also receive interest as cash flow from the deposit.

Learn more about Senior Citizens Savings Scheme.

Thus, if you can plan for about three to five years, you can convert taxable commuted pension to tax-free at a rate of Rs 1.5 lakhs a year.

You can use a commuted pension to fulfil your retirement goals. The monthly pension you receive from your retirement savings is fully taxable. However, if you are just starting your retirement investments you can use online ULIP plans like Invest 4G to build a tax-free pension after 60.

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Invest 4G is a ULIP plan from Canara HSBC Bank of Commerce life insurance and allows a holding period of up to 99 years of age. This means you can build a corpus from 30 to 60 or 65 and draw a tax-free lifetime pension after that. Additionally, upon your natural demise, the plan will pay higher of the sum assured or fund value to your nominees. Thus, fulfilling another life goal for you – legacy.

You should only commute as much as you need to meet your retirement goals. It is equally important that you receive a decent monthly income to maintain the same living standards. With the above information, you know how commuted income is taxed and what is the tax exemption. You should take care of your commutation limits.

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard.

FAQs

What is the commuted value of a pension? ›

A commuted value represents the lump sum present value of the pension you would otherwise receive as a monthly payment for your lifetime upon retirement.

What is the meaning of commuted pension? ›

Commutation of Pension means payment of lump sum amount in lieu of a portion of pension surrendered voluntarily by the pensioner based on a duration of period in relation to the age. This is purely an optional facility provided by the Government to the pensioner.

How do you calculate the commuted value of your pension? ›

The commuted value is then divided by the life expectancy of the employee to calculate the annual pension benefit payable to the employee. If you're a mathematician, here's the typical formula to calculate commuted value: PV = FV/ (1 + k)^n.

How much is a $30000 pension worth? ›

As an example, examine how much an earned pension income of $30,000 would add to a person's net worth. A defined benefit plan income of $30,000 annually is $2,500 per month, which is 25 times $100.

How is commuted value of pension taxed? ›

The commuted pension is fully exempt from income tax for government employees. For a non-government employee who receives pension along with gratuity, 1/3rd of the 100% of the commuted pension is exempt. The rest is taxed, like their salary.

Is it better to take the commuted value of my pension? ›

If you were to take the commuted value of your pension and then lived a long time, without ongoing planning it is possible that you could outlive the assets in your account. If on the other hand you remained in the pension your pension benefit is guaranteed until you pass away.

Is commuted pension income taxable? ›

If the amount of commuted pension exceeds the aforesaid limits, such excess pension received is liable to tax.

How much of my pension is taxable? ›

Unless you choose no withholding, a lump-sum benefit that is not an eligible rollover distribution, the taxation is 10% of the distribution.

How can I avoid paying tax on my pension? ›

How can I avoid paying tax on my pension? The way to avoid paying too much tax on your pension income is to aim to take only the amount you need in each tax year. Put simply, the lower you can keep your income, the less tax you will pay. Of course, you should take as much income as you need to live comfortably.

How much of commuted pension is exempt? ›

Non-Govt. Employees : i) Where the employee receives gratuity, amount not exceeding the commuted value to the extent of 1/3rd of the pension is exempt. ii) In other cases : the commuted value of ½ of pension is exempt.

What is the maximum percentage of pension that can be commuted? ›

Limit on commutation of pension -

(1) A Government servant shall be entitled to commute for a lump sum payment a fraction not exceeding forty percent of his pension.

How do I calculate my pension amount? ›

A typical multiplier is 2%. So, if you work 30 years, and your final average salary is $75,000, then your pension would be 30 x 2% x $75,000 = $45,000 a year. That $45,000 becomes your guaranteed lifetime income.

What is a good average pension? ›

A good pension income will be dependent on your own circumstances and finances but, as a guide, a good starting point would be around 2/3 of your working salary.

Is Social Security part of net worth? ›

The reason Social Security often is excluded from standard measures of net worth is that it is an annuitized form of wealth—people receive their Social Security benefits as a stream of income. As such, they rarely consider how much wealth that stream of income represents, and are not asked about it by economic surveys.

How much is the average pension per month? ›

The average income for U.S. adults 65 and older is $75,254. The median income for U.S. adults 65 and older is $47,620. Average annual expenses for adults 65 and older are $48,872. The average monthly Social Security benefit for retired workers is $1,681 and is set to rise to $1,827 in 2023.

Is pension taxable for senior citizens? ›

The pension received by you is taxable under the Income head 'Salaries' beyond the exemption limit. Will I get benefits of Standard Deduction? From AY 2020–21, a standard deduction upto Rs. 50,000 against salary income earned during the year has been introduced under u/s 16 of I-T Act, 1961.

How can I avoid paying tax on my pension lump sum? ›

You may be able to defer tax on all or part of a lump-sum distribution by requesting the payer to directly roll over the taxable portion into an individual retirement arrangement (IRA) or to an eligible retirement plan.

What is the most tax efficient way to take pension? ›

Don't draw your pension in one go

As is evident from the points above, staggering your pension so that you receive less on an annual basis ultimately means you will pay less tax. While you might be tempted to empty your pension pots in one go, it will mean paying income tax on that amount in one year.

Is it a good idea to take 25 of your pension? ›

Taking your 25% lump sum is tax-free and won't affect your income tax rate when you take it, unlike the remaining 75% of your pot. Not withdrawing your pension keeps your money protected from inheritance tax and allows you to carry on benefiting from tax-free growth- if your investments perform well.

Is it better to take my pension in a lump sum? ›

A Lump Sum Gives You More Control of Your Assets

By accepting a lump sum from the pension, you gain the control over your income assets. Even if the income generated from the lump sum is less than the promised annuity payment from the pension, you gain control over the assets.

Is pension income included in taxable income? ›

If your spouse or partner has died and could receive pension benefits, you may receive a survivor's pension, usually at a reduced amount. Your private pension income is fully taxable in the year(s) you receive it.

At what age are pensions not taxable? ›

Distributions from traditional IRAs and 401(k) plans are taxed as ordinary income (although certain distributions may only be partially taxable). However, beginning in 2023, the first $6,000 of retirement income received by anyone 65 years of age or older will be exempt.

What is the simplified method to determine the taxable amount of a pension? ›

The dollar amount is determined by dividing the total amount of your previously taxed contributions (you can find this amount on your IMRF Certificate of Benefits) by the number of pension payments you can expect to receive.

Do I have to file a tax return if I receive a pension? ›

If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable unless the payment is a qualified distribution from a designated Roth account.

What is difference between pension and commuted pension? ›

Generally, the employer and taxpayer contribute together to an annuity fund, which pays the taxpayer pension out of the fund. At the time of retirement, you may choose to receive a certain percentage of your pension in advance. Such pension received in advance is called commuted pension.

What is difference between commuted pension and gratuity? ›

Gratuity involves one-off payment in which the entire sum is provided by the employer at once. Unlike pension wherein, the employee gets a fixed sum in the form of monthly instalments. For the entitlement of pension, at least ten years of contributory service is required.

How do I calculate my pension payout? ›

A typical multiplier is 2%. So, if you work 30 years, and your final average salary is $75,000, then your pension would be 30 x 2% x $75,000 = $45,000 a year. That $45,000 becomes your guaranteed lifetime income.

Which pension is exempt from income tax? ›

Income Tax on Commuted Pension

Received from Govt employer: Fully Exempt from Income Tax. In other words, no income tax on pension received from Govt.

Can you collect Social Security and a pension at the same time? ›

Yes. There is nothing that precludes you from getting both a pension and Social Security benefits. But there are some types of pensions that can reduce Social Security payments. Get instant access to members-only products and hundreds of discounts, a free second membership, and a subscription to AARP the Magazine.

How much will my Social Security be reduced if I have a pension? ›

We'll reduce your Social Security benefits by two-thirds of your government pension. In other words, if you get a monthly civil service pension of $600, two-thirds of that, or $400, must be deducted from your Social Security benefits.

What are the 3 states that don't tax retirement income? ›

States That Won't Tax Your Pension Income

Alaska. Florida. Nevada. South Dakota.

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