How Pension Income is Taxed in India

In India, a pension represents a regular income stream for individuals after their retirement from active employment. The taxability of this income is contingent on several factors, including the retiree’s former employer and the specific manner in which the pension is received. The rules governing pension taxation are detailed within the Income Tax Act, 1961, which sets out a framework that differentiates based on how and from whom the pension is paid.

Tax Treatment of Uncommuted Pension

Uncommuted pension refers to the periodic payments, made monthly, that a retiree receives. This form of pension is treated as income and is fully taxable for all individuals, irrespective of whether their previous employer was a government entity or a private sector company. The Income Tax Act classifies this regular pension under the head ‘Salaries’, meaning it is taxed in the same manner as salary income earned during one’s employment years.

To provide some relief to pensioners, the tax law allows for a standard deduction from this income. A deduction of ₹50,000 can be claimed against the total uncommuted pension received during a financial year. This benefit is available to pensioners regardless of whether they opt for the old or the new tax regime.

After applying the standard deduction, the remaining pension amount is aggregated with the individual’s other sources of income, such as interest from savings or rental income. This total income is then taxed according to the income tax slab rates applicable to the individual for that particular financial year.

Tax Treatment of Commuted Pension

Commuted pension is the lump-sum amount a retiree receives by choosing to forgo a portion of their future monthly pension payments. The tax treatment of this lump-sum payment varies significantly based on the retiree’s employment history. For individuals who were employed by the central or state government, a local authority, or a statutory corporation, the entire amount received as a commuted pension is completely exempt from income tax.

The situation is more detailed for employees retiring from the private sector. For these individuals, the tax exemption on their commuted pension is contingent on whether they also receive a gratuity payment at retirement. Gratuity is a separate lump-sum benefit paid by an employer for the services rendered by an employee.

If a private-sector employee receives a gratuity in addition to their pension, one-third of the amount of pension that the employee would have received had they commuted 100% of their pension is exempt from tax. For instance, if an employee commutes 60% of their pension for ₹9,00,000, their full commuted pension would be ₹15,00,000. The tax-exempt portion would be one-third of this full amount, which is ₹5,00,000, and the remaining ₹4,00,000 would be taxable.

A different rule applies if the private-sector employee does not receive any gratuity. In this scenario, the tax exemption is more generous. One-half of the amount of pension the employee would have received had they commuted 100% of it is exempt from tax. Using a similar example, if an employee without gratuity commutes 60% of their pension for ₹9,00,000, the full commuted value is still ₹15,00,000. The tax exemption would be one-half of this, amounting to ₹7,50,000, with the balance of ₹1,50,000 being taxable.

Special Pension Scenarios

Family Pension

Family pension is a payment made to the legal heirs of a deceased employee. It is not taxed under the ‘Salaries’ head but is instead considered ‘Income from Other Sources’. The Income Tax Act provides a specific deduction for family pension recipients. The available deduction is one-third of the pension amount received or ₹15,000, whichever is lower. This deduction can be claimed by family pension recipients under both the old and new tax regimes.

Pension for Non-Resident Indians (NRIs)

Pension income that accrues or is received in India by a Non-Resident Indian (NRI) is taxable in India. To prevent the same income from being taxed in both India and the NRI’s country of residence, India has signed Double Taxation Avoidance Agreements (DTAAs) with numerous countries. An NRI can claim relief under the relevant DTAA, which may offer an exemption in one country or allow for a tax credit for taxes paid in the other. To claim these benefits, the NRI needs to provide a Tax Residency Certificate (TRC) from their country of residence and file specific forms, such as Form 10F.

Pension from International Organizations

A distinct rule applies to pensions received from certain international organizations. Pensions paid by organizations such as the United Nations Organisation (UNO) are exempt from tax in India. This exemption is often stipulated in the agreements that establish these organizations and is recognized under Indian tax law.

Reporting Pension Income on Your Tax Return

The bank or financial institution that disburses the pension is required to deduct Tax Deducted at Source (TDS) if the pensioner’s total annual income exceeds the basic exemption limit. After the financial year, the pensioner will receive a Form 16 from the paying entity, which details the total pension paid and the amount of tax deducted.

For most pensioners whose income consists of their pension and interest from savings, the ITR-1 (Sahaj) form is the appropriate choice, provided their total income is up to ₹50 lakh. This form can also be used by individuals who receive a family pension, as this income is reported under the ‘Income from Other Sources’ head.

When filling out the ITR form, uncommuted pension is reported in the section for ‘Salaries’. For those receiving family pension, the net taxable amount is entered under the ‘Income from Other Sources’ schedule. Any tax-exempt portion of a commuted pension should also be reported in the relevant schedule for exempt income.

Pensioners can claim various deductions to reduce their final tax liability. These include deductions under Section 80C for specified investments and Section 80D for health insurance premiums. A deduction for senior citizens under Section 80TTB allows them to claim up to ₹50,000 on interest income earned from deposits in banks and post offices.