Valuation of Retirement Benefits – for Calculating Taxable Salary Income – Direct and Indirect Taxes with Tax Ready Reckoner

Retirement benefits such as pension, gratuity, provident fund, and leave encashment are taxed differently under the Income Tax Act, 1961. Below is a detailed breakdown of their valuation and tax treatment:

Table of Contents

1. Pension Income

Pension is classified into commuted (lump-sum) and uncommuted (periodic) pensions.

A. Commuted Pension (Lump-Sum Payment)

EMPLOYEE TYPE	TAXABILITY	EXEMPTION FORMULA
Government Employees	Fully exempt	N/A
Non-Government Employees	Partially exempt

If gratuity received: Exempt up to ⅓of pension value.
If no gratuity received: Exempt up to ½of pension value.

Example:

A private employee receives ₹12 lakh as commuted pension (60% of total pension) and gratuity.
Exemption= (⅓ × ₹12 lakh / 60%) × 100 = ₹6.67 lakh (taxable portion = ₹5.33 lakh).

B. Uncommuted Pension (Monthly Payments)

Fully taxableas salary income for all employees.

2. Gratuity

Taxability depends on employment type and amount received:

EMPLOYEE TYPE	EXEMPTION LIMIT	TAXABLE AMOUNT
Government Employees	Fully exempt	N/A
Private Employees (Covered under Payment of Gratuity Act, 1972)	₹20 lakh (or actual gratuity, whichever is lower)	Excess over ₹20 lakh
Private Employees (Not covered under Gratuity Act)	₹10 lakh (or actual gratuity, whichever is lower)	Excess over ₹10 lakh

3. Provident Fund (PF)

A. Recognized Provident Fund (RPF)

Employer’s contribution > 12% of salary= Taxable perquisite.
Interest earned > 9.5% p.a.= Taxable.

B. Unrecognized Provident Fund (UPF)

Employer’s contribution + interest= Taxable at withdrawal.

C. Public Provident Fund (PPF)

Fully exempt (E-E-E status).

4. Leave Encashment

EMPLOYEE TYPE	EXEMPTION LIMIT	TAXABLE AMOUNT
Government Employees	Fully exempt	N/A
Private Employees	₹3 lakh (lifetime limit)	Excess over ₹3 lakh

5. National Pension System (NPS)

Employer’s contribution (up to 10% of salary)= Exempt.
Employee’s contribution (up to ₹1.5 lakh under Section 80CCD(1))= Deductible.
Additional ₹50,000 under Section 80CCD(1B)= Deductible.

6. Superannuation Fund

Employer’s contribution (up to ₹7.5 lakh/year)= Exempt.
Excess contributions= Taxable perquisite.

7. Annuity Payments from Pension Plans

Fully taxableas salary income (if purchased via employer scheme).
Taxable under “Income from Other Sources”(if purchased privately).

8. Reporting in ITR

Pension & Gratuity: Report under “Income from Salaries”4.
Family Pension: Taxable under “Income from Other Sources”(with ₹25,000 exemption).

Summary Table: Tax Treatment of Retirement Benefits

BENEFIT	GOVERNMENT EMPLOYEE	PRIVATE EMPLOYEE	TAXABLE PORTION
Commuted Pension	Fully exempt	⅓ or ½ exempt	Excess over exemption
Uncommuted Pension	Fully taxable	Fully taxable	100%
Gratuity	Fully exempt	₹10/20 lakh exempt	Excess over limit
Leave Encashment	Fully exempt	₹3 lakh exempt	Excess over limit
NPS (Employer Contribution)	Exempt up to 10% of salary	Exempt up to 10% of salary	Excess over limit
Superannuation Fund	Exempt up to ₹7.5 lakh	Exempt up to ₹7.5 lakh	Excess over limit

Key Notes…

Government employeesenjoy full exemption on gratuity and commuted pension.
Private employeesmust calculate exemptions carefully, especially for gratuity and pension.
NPS and Superannuation Fundsoffer tax benefits but have contribution limits.
Leave encashmentbeyond ₹3 lakh is taxable for private employees.