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The absence of a social security system in India makes retirement planning mandatory for everyone. Based on the existing tax regimen, here is an analysis of some retirement-saving alternatives from an income-tax perspective at the time of investing and while withdrawing:
Public Provident Fund (PPF)
The interest accruals and withdrawals are exempt from income tax. However, the maximum limit of investment in the PPF scheme is limited to Rs 70,000 a year.
Pension funds
The pensioner can take a periodic pension or a lump-sum amount at the time of retirement (called commuted pension). Let’s say Kumar, who has been contributing Rs 50,000 to a pension fund, will retire next year. He will receive a monthly pension of Rs 30,000. The contribution of Rs 6 lakh to the pension fund is deducted from his taxable income up to a total of Rs 1 lakh. As he is in the highest tax bracket, Ram will get a tax break of Rs 33,990 (i.e. 33.99% on Rs 1 lakh). Post retirement, his monthly pension will be taxed as salary at the applicable slab rates. If Kumar takes a lump-sum payment, the amount will be tax-free.
If Kumar works for a private company, he may receive a monthly pension from his employer. This will be taxed as salary as in the previous case. However, if Kumar passes away and his family receives the pension, it will be taxed as “income from other sources” in the hands of the family member receiving it. One-third of the pension, subject to a maximum of Rs 15,000, is allowed as deduction.
The taxation of commuted pension from a private employer depends on whether gratuity is also given to the employee. If he is given gratuity, one-third of the amount is tax-exempt. If not, half the amount will be tax-exempt.
The gratuity will be tax-exempt up to half-a-month’s salary (the average of past 10 months’ salary is used for computation) for each year of service. The maximum limit is Rs 3.5 lakh. If gratuity was claimed as tax exemption in earlier years, the unutilised portion of Rs 3.5 lakh is permissible as exemption.
Life insurance policy
The life insurance premium paid by an individual is eligible for deduction up to a total of Rs 1 lakh. The returns from a life insurance policy, including the bonus, are tax-free, except in specific situations.
Other investments
Mediclaim payments of up to Rs 10,000 (Rs 15,000 for senior citizens) are allowed as deduction from income. Reimbursement of medical expenses are also not taxable. Investments of up to Rs 1 lakh a year in equity linked savings scheme (ELSS) are deducted from your income. The returns from ELSS are tax-free.
Investments of up to Rs 1 lakh in 5-year fixed deposits with scheduled banks are allowed as deduction from income. But the interest on fixed deposits is subject to tax at individual slab rates.
A single deduction of up to Rs 1 lakh is permissible under Section 80C for all the instruments that have been mentioned.
— Giselle Barboza, Senior tax professional, Ernst & Young
