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Commuted Pension

A pension plan is an investment for the long run that will shield your financial future after retirement. A commuted pension lets you to receive a lump payment at once and the remaining amount in predetermined installments during your lifetime. Read this blog to learn more about the commuted pension scheme in detail.

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Commuted Pension

Guide on Commuted Pension Scheme

Commuted Pension Scheme
June 14, 2024

Table of Content

 

A pension plan is a long-term investment to secure your financial life after retirement. Being a responsible pension policyholder, there are two options for types of pension plans to opt for: either receiving the pension amount monthly or as a lump sum in advance. Prior financial planning is thus needed to determine the commuted value of a pension plan. This assists you in achieving your desired financial goals.

Continue reading this blog to know more about the commuted pension scheme in detail.

What Is a Commuted Pension?

During years of working, you invest a certain amount in the annuity fund to receive a stable income as a pension once you retire. To receive the accumulated amount after retirement, you can choose a monthly mode or advanced payment of a lump sum amount.

If you opt for a one-time lump-sum payout from a pension plan instead of getting smaller amounts in intervals, it is referred to as a commuted pension. In other words, a commuted pension allows you to receive a lump sum amount at a time and the remaining amount in fixed installments throughout your life.

Central Government employees can commute up to 40% of their pension as a lump sum payment without the need to undergo a medical examination before retirement. However, medical examination is required in case the commutation facility is availed after retirement.

How to Calculate Commuted Pension?

Commuted pension is easy to calculate using a pension calculator. The pension calculator considers personal details such as age, savings and investment, current income, daily expenses, and retirement age.

To calculate a commuted pension, here is the formula considered:

Commuted Value = 40% of P * CF *12

Where P = Pension Ordered

CF = Commutation Factor

Following this formula, we can calculate commuted pension considering the data given in the table below:

Age (next birthday) Commutation Value Expressed as Number of Year’s Purchase
20 19.01
21 18.91
22 18.81
23 18.70
24 18.59
25 18.47
26 18.34
27 18.21
28 18.07
29 17.93
30 17.78

Advantages of Commuted Pension

Availing the commutation facility might sound challenging and risky, but there are several advantages. Here is a detailed overview of the benefits of commuted pension.

  • Financial Flexibility

With pension commutation, you can achieve financial flexibility. A traditional pension provides you with a fixed monthly income in your retirement years. This allows you to possess control over your finances and stay independent financially.

  • Investment Opportunities

The commutation facility lets you invest a large sum of money in stocks, bonds and real estate. Thus, your overall return increases with the diversification of your investment portfolio.

  • Freedom of Choice

Pension commutation offers you the freedom of choice of using the lump sum amount received as a pension. Thus, you can access lump sum cash immediately. With the amount received, you can choose to start a new business, pay off debts or invest in large purchases without worrying about pension payments.

  • Elimination of Longevity Risk

Pension commutation allows you to maintain a decent standard of living with comprehensive insurance coverage throughout your life.

  • Estate Planning

Pension commutation is an important tool for estate planning. After receiving the lump sum amount as a pension, you can transfer it to your beneficiaries after death. Thus, it will provide financial assistance to your family in your absence. It will also be treated as a valuable, stable source of income.

Disadvantages of Commuted Pension

Retirees who want early access to pension funds will consider commuted pension advantageous. However, apart from the advantages, there are a few disadvantages of this pension withdrawal facility:

  • Risk of Mismanagement

Opting for the pension amount in a lump sum can be challenging to manage. Thus, there are some risks of mismanagement of funds. If you don’t have sufficient financial knowledge or you fail to make a proper financial plan, you might end up spending the fund amount quickly or reach a poor investment decision.

  • Loss of Guaranteed Income

Opting for a commuted pension results in a loss of your guaranteed1 monthly income. This is because you are exchanging future pension income with a lump sum payment. This might appear to be a good idea in the short term but it creates an adverse effect on your long-term financial security.

  • Tax Implications

This is another disadvantage of commuted pensions. The lump sum amount received as a pension is subjected to taxation, which implies that you are liable to pay a significant portion of the tax on the lump sum amount received. Moreover, if your age is 55 or below, you might have to face additional penalties on taxes.

  • Inflation Risk

Inflation risk is another risk factor associated with commuted pensions. Commuting pension implies locking a fixed amount of money, which is not responsive to changes in inflation. If you cannot grow your money, it will lose its purchasing value over time.

  • No Lifetime Protection

Traditional pensions provide retirees with a guaranteed1 income for a lifetime. This is, however, different for commuted pension. It offers no guaranteed1 income and, thus, no lifetime protection. Once you complete spending the lump sum amount, there will be no fixed monthly income. Thus, you may not have sufficient funds in your hand in later life during urgent situations.

Taxation on Commuted Pension

The tax on commuted pension differs from one person to another. Let us discuss it in detail:

  • Government Employee

The commuted pension that government employees receive is exempted from taxes.

  • Private Employee

Whether the commuted pension that private employees receive will be exempted from taxes depends on the gratuity received. This thereby gives rise to two scenarios:

a) An individual receives both pension and gratuity: If there is a 100% commuted pension, then one-third of the pension amount is exempted from taxes while the remaining half is subjected to taxation as salary.

b) An individual receives only a pension and not gratuity: If there is a 100% commuted pension, then 50% of the pension amount is exempted from taxes.

Do you Need to File an ITR for Commuted Pension?

Filing ITR is mandatory if the commuted amount received is higher than the tax-exempt amount. In this case, you need to pay the full tax amount on the extra commuted amount received. To avoid taxation for commuted pension, fill out Form 10E. The government imposes certain relaxations under Section 89 of the Income Tax Act2.

You can face financial emergencies anytime. A commuted pension serves the purpose during this urgent situation. However, because the commuted pension amount is subject to taxation, make sure to address the tax exemption limit before you opt for such options.

On the other hand, if you get an uncommuted pension, it is mandatory to file ITR 1 as the entire pension amount is taxable.

Conclusion

Commuted pension is ideal for retirees with financial goals, as they can opt for a lump sum payment in advance rather than monthly disbursements. This option is particularly beneficial for those needing urgent funds or looking to invest in diverse portfolios. When considering various pension plan comparisons, it's essential to incorporate financial planning to achieve retirement goals and maintain a decent standard of living.

FAQs on Commuted Pension

1. What is the difference between a commuted and uncommuted pension?

When you receive a lump sum amount from a pension plan, it is a commuted pension. On the other hand, when you receive the full pension amount without lump sum withdrawal, it is an uncommuted pension.

2. What is the commuted value of a pension?

The commuted value of a pension is when you withdraw a lump sum amount without affecting your future gains.

3. Which is better- commutation or full pension?

A commuted pension is better than a full pension because, with a commuted pension amount, you can meet your financial urgencies. However, if you prefer small but regular payouts, you can choose an uncommuted pension. Make sure to understand the tax implications before opting for either option.

4. How is the commutation amount of a pension calculated?

The formula for calculating the commutation amount of a pension is:

Commuted Value = 40% of Pension ordered * Commutation Factor *12

5. How much pension will I get after the commutation?

After commutation, you can expect to receive a certain portion of your pension, not more than 40% of the amount.

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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Disclaimer

1. Provided all due premiums have been paid and the policy is in force.

2. Tax Laws are subject to change from time to time. Tax benefits are subject to conditions under Sections 80C, 80D, Section 10(10D) and other provisions of the Income Tax Act, 1961.

HDFC Life Guaranteed Pension Plan (UIN: 101N092V14) is a non-linked non-participating pension plan. Life Insurance Coverage is available in this product.

HDFC Life Click 2 Retire (UIN No: 101L108V04, Form No: P501) is a Unit Linked Pension Product.

HDFC Life Smart Pension Plan (UIN:101L164V03) A Unit Linked, Non-Participating Individual Pension Plan.

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