Pension is a fund into which regular contributions are made by you as the employee during your employment years. This sum is accumulated and invested during your employment years and is available for withdrawal either in installments or regular payments or as a lump sum during your retirement years after you cease employment. Pensions can be either on a defined benefit or defined contribution basis.
A defined benefit Pension is a plan where the retirement benefit is estimated beforehand. A defined contribution is a plan where the benefit payable is not known but the defined contribution to the pension plan is estimated.
Pensions paid by the employers is a form of deferred payment which helps both the employer and the employee in tax planning. Most plans in India are defined contribution plans where there is both the employer contribution and the employee contribution. The employer contribution may be equal to the employee’s contribution subject to a ceiling. The performance of the pension plan depends on the total amount of contributions made by you during the course of your employment and the accumulated investment returns on the corpus-based on the types of investment vehicles used and the asset allocation model.
India has a complicated system of Pension. There are four types of Pension payments in India.
· National Social Assistance Programme which provides pension assistance to the elderly poor.
· Civil Servants Pension Scheme for Central and state government employees and the
· Employees’ Provident Fund Organisation of India which provides pensions for Private sector employees, employees of state owned companies, and several voluntary plans.
· Armed forces Service Pension which is administered by the Department of Ex-servicemen welfare which takes care of the all Pension needs of Army, Navy and Airforce personnel.
Key Takeaways
We are most financially vulnerable in our retirement years unless we have adequately planned our financial and investment portfolio to meet our retirement needs. Pension systems in India have been set up to create compulsory savings so that we can live our retirement years with financial independence and dignity. We should always supplement our pension flows by creating voluntary savings, which when accumulated can go a long way towards meeting our financial needs. Retirement years are for relaxation and enjoyment, travel, visit places. So if you have been prudent in your savings when you were employed, you can enjoy a peaceful retirement free from worries.
Public pensions: There are two aspects to this:
· Providing a safety net for the needy elderly population. There are 16 million people who avail of this scheme which pays Rs 200 monthly.
· Pension for civilian employees of which there are two components – a gratuity based on final 15 days salary for every year of completed service subject to a maximum of Rs 3, 50,000 paid to employees with over 5 years of tenure. Members can contribute anywhere from 6% to 100% and benefits are paid as a lump sum after 20 years of service. The accumulated corpus earns interest rate at 8.5% p.a. paid by the government.
· A new pension scheme has been introduced in which employers and employees contribute 10% of the employees’ salary and the contributions are placed in individual accounts. The New Pension aims at a targeted replacement of the final wage. The return on the accumulated portfolio is 8%. This scheme is mandatory for all civilian servants but anyone can join. A choice of three types of funds is offered based on different return–risk parameters. If the employee does not make a choice then the investment is transferred to a safe fund.
Employee Provident Fund Organisation Schemes:
· There are three schemes: The employees’ Pension scheme, the Employees’ deposit linked insurance scheme and the Employees Provident Fund Scheme.
· The first and the third are pension plans.
· In the Employees’ Pension scheme, the employer and the government contribute 8.33% and 1.16% of the salary respectively.
· Retirement is at the age of 58, but early retirement with reduced benefits can be availed from the age of 50 onwards.
· This covers about 32 million members.
· The assets under the scheme are administered by Government-owned banks.
· The Employer’s Provident Fund is a defined contribution plan scheme.
· Employers and Employees contribute 3.67% of the wages. Employees can contribute up to 100% of the scheme.
· Employees can make partial withdrawals to meet large financial expenses.
· The rate of return on the accumulated corpus is 8.5% p.a.
· The Employees Provident Fund scheme covers 43 million employees.
Commutation of pension
Eligibility: Every pensioner is eligible to commute a portion of his monthly pension for a lumpsum payment. This represents the commuted value of that portion of the pension. An employee or pensioner against whom departmental or judicial proceedings are pending is not allowed to commute a portion of his pension till the completion of such proceedings. The employee can commute either the whole or a part of his pension.
Commutation of Pension Formula:
· Total Commutation Amount = Commuted Amount x Commutation Factor x 12
· For example, if the pension amount is Rs 50,000, then the maximum commuted pension amount is 50000* 50/100 = Rs 25,000
The table for Commutation factors is given below:
The figures in the table are age at the next birthday and the commuted value of the pension available at the next birthday
Formula for working out the lump sum payable
If an employee retired on July 2018 with a basic pension of Rs. 24,500, then the formula for working out his lump sum is as follows:-
Amount of pension offered for commutation = Rs 9,800 (Rs 24,500*40%)
Age on his next birthday is 62 years in 2022.
Commutation factor is = 8.093
Lumpsum Amount: Rs 9800 X 12X 8.093 = Rs 951,736.8
Reduced monthly pension amount is Rs 14,700 payable as pension every month.
The reduction in the amount of commuted pension will become applicable from the date of application for the commutation of pension or at the end of 3 months after the issue of authority for payment whichever is earlier. The restoration of the commuted pension will be admissible after the completion of 15 years. The pensioner has to apply for the same to the pension disbursing authority.
Please follow the below link for the form for restoration of full pension after 15 years.
Maximum and Minimum Pensions amounts after the 7th Pay Commission recommendations: The minimum pension amount is Rs 7,000 and the maximum pension amount is Rs. 1,25,000 per month.
For members of the Employees Provident Fund Organisation who had partially commuted their pensions when they retired before September 26th, 2008, the government has allowed full restoration of their pension after 15 years of such retirement.
According to the Employees’ Pension Scheme, those employees who retired before September 26th, 2008 can get a maximum of 1/3rd of their pension as a lump sum commuted pension, while the remaining 2/3rd of their pension will be payable as a monthly pension during their lifetime.
Pension Commutation calculator
Taxation of commuted pensions:
Pension income is also taxable according to the provisions of the Indian Income-tax Act. Regular pension income is taxable as per the following slabs under the Indian IT Act. The source for the below information is given below:
Commuted pensions are fully tax-exempt for Government employees. The commuted pension is partially tax-exempt for non-government employees. The exemption on commuted pensions is available under Section 10(10A) of the Indian Income-tax Act.
Under this definition, Government employees would include central government employees, state government employees, employees of a local authority, and employees of statutory authority. In case other private employees and other employees, commuted pensions are only partly tax-exempt. Please refer to the sections of the Indian Income-tax Act for the detailed provisions which affect your commuted pension amounts.
In summation:
If you decide to commute your pensions, you should be thoroughly aware of all the facts relating to your pension payments, the provisions of the National Pension Act, the revisions in the monthly pension payment after such commutation, and all the provisions of the Indian Income Tax Act as they apply to your pensions. Instead of solely depending on your employer and government pensions, make it a habit to regularly save money in order to ensure that you have a sufficient bulwark of savings to protect you from financial exigencies and emergencies in your retirement years. Financial planning during your career goes a long way in helping you meet unexpected demands in your retirement years.
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