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Tax Planning for Retirement

After you have worked all through your life and saved for your retirement years, you may think your task is complete. However, this is not the case, as your post-retirement savings can crumble if you have not invested the funds properly or failed to avail any tax benefits. ...Read More

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Tax Planning for Retirement

Tax Planning in Retirement: A Comprehensive Guide

Tax Planning in Retirement: A Comprehensive Guide
September 23, 2024

Table of Content

 

Tax Planning for Retirement Income

Retirement planning can be quite complex, and neglecting the tax implications of your retirement savings can significantly impact your pensions. Here are a few strategies you can follow to manage tax liability post-retirement:

1. Be Aware of Applicable Taxes

Whether you want to invest in mutual funds or pension plans to fund your retirement, you must understand how the income will be taxed. If you have retirement income from under different heads like long-term capital gains, short-term capital gains, income from other sources, etc., you must anticipate that you have to pay taxes on these income sources.

Although long-term capital gains are taxed at 12.5%, you can save tax on this. To do this, you can realise gains of up to Rs. 1.25 lakh annually (which is tax-exempt) by selling profitable investments and subsequently repurchasing the same stocks or mutual funds. Furthermore, you can opt for more tax-efficient investments like NPS, PPF, EPF, etc.

2. Optimise Your Investment Portfolio for Tax Efficiency

Upon retirement, your tax liability can include taxes on dividends, capital gains, interest income, and income from property and so on. If you don’t plan for tax savings, your income will be pushed into higher tax slabs, which will lower your overall income for the rest of your life. 

Hence, tax-efficient investment strategies can help minimise your tax liability by changing your investment portfolio to include various tax-saving instruments. Take steps like holding long-term investments to avail lower capital gains tax and changing your retirement account into a tax-advantaged account, etc. Therefore, it will reduce the post-retirement tax liability each year and help you reduce your taxable income.

3. Invest in a Deferred Annuity

A deferred annuity is an insurance product created for retirement planning, providing you with a fixed income starting at a future date of your choice. While working, you can invest in a deferred annuity plan as it acts as a source of steady income through savings for your retirement. 

With this income, you can fulfil various dreams after retirement, like buying a house, travelling, indulging in hobbies, or embarking on newer adventures. You can consider making partial withdrawals over time from the annuity rather than taking large lump-sum withdrawals. It can help you manage your taxable income more effectively and potentially stay within lower tax brackets.

4. Use Tax-Advantaged Accounts Before You Retire

To prepare yourself for tax planning for retirement, you can utilise the advantage of investing in tax-saving investment options before retirement. Here are several options you can consider using as tax-advantages accounts before you retire:

  • Investing in savings bank accounts, bank deposits, or post office deposits can benefit from deductions of up to Rs. 50,000 on the interests earned under Section 80 TTB in case of senior citizen.
  • You can claim tax deductions under Section 80C and Section 80CCD by increasing your contributions to the Public Provident Fund (PPF) and National Pension System (NPS).
  • Consider reducing your tax burden by investing in retirement-focused ULIPs, which offer tax benefits on the maturity amount under Section 10(10D).

How Retirement Taxes Are Calculated?

Even during the absence of your salary, you can get regular income through property rental, capital gains, and the interest accrued from investments. Each of these income sources is subject to taxation. The tax amount varies according to your age and annual income.

Pension income taxation depends on whether you receive a lump sum amount (commuted pension) or instalments spread throughout time (non-commuted). 

Uncommuted Pension i.e regular monthly pension/annuity is always taxable  for all types of taxpayers and is subject to taxation based on the applicable income tax slabs. The amount received periodically is added to your total income for the year, and taxes are levied accordingly.

Income tax Implications on Commuted pension or lump sum pension is as below -

For Government Employees : Fully Exempt

For Non Government Employees:

1. Employee receives both Gratuity & Pension : Assuming 100% pension is commuted, 1/3rd of the pension amount is exempted & remaining is taxed as salary.

2. Employee does not receive Gratuity i.e. only pension is received :  Assuming 100% pension is commuted, ½ of the pension amount is exempted & remaining is taxed as salary

3. Any payment received in commutation of pension as a lump sum on vesting (maturity) from a Pension Plan of a life insurance company is completely exempt, subject to fulfillment of various conditions under the current income-tax law.

Other than pension, Indian employees may receive benefits at the time of retirement in the form of gratuity, provident fund payments or VRS (Voluntary Retirement Scheme). Each of these carry different tax benefits, which are explained below:

  • Gratuity : Gratuity taxation depends on the employee type.
  • For government employees, it’s fully tax-exempt.
  • For non-government employees under the Payment of Gratuity Act, the least of actual gratuity or ₹20 lakhs or 15 days’ salary for each completed year of service (calculated as the last drawn salary divided by 26, multiplied by 15, and then multiplied by the number of completed years of service) is exempt; excess is taxable.
  • For non-government employees not under the Act, least of actual gratuity or ₹20 lakhs or half month’s salary for each completed year of service (calculated as the average salary of the last 10 months). is exempt; the remainder is taxed.

  • Provident Funds: Provident Fund taxation depends on the type of fund:
  • Statutory Provident Fund (SPF): Interest earned and withdrawals are fully exempt from tax.
  • Recognized Provident Fund (RPF): Employer contributions up to 12% of salary are tax-exempt; interest up to 9.5% per annum is tax-free. Withdrawals are tax-exempt if conditions (like 5 years of continuous service) are met.
  • Unrecognized Provident Fund (URPF): Employer contributions and interest are taxable upon withdrawal.
  • Public Provident Fund: Contributions made towards the Public Provident Fund (PPF) are eligible for tax deduction under Section 80C. The maximum deposit limit for PPF is Rs. 1,50,000 a year, which means you can claim the entire deposited amount as an exemption under the Income Tax Act.

  • Voluntary Retirement Scheme (VRS): Compensation received under VRS is exempt from tax under Section 10(10C) of the Income Tax Act, subject to the conditions least of Rs 5 Lakhs or actual amount received or salary p.m. multiply by number of remaining month of service or salary p.m. X 3 months X Number of years of completion of service.

  • Leave Encashment: Leave encashment taxation depends on the type of employee:
  • Government Employees: Leave encashment at the time of retirement or resignation is fully exempt from tax.
  • Non-Government Employees: Leave encashment is taxable, but at retirement or resignation, the least of the following is exempt under Section 10(10AA):

₹25 lakhs (for retirement after February 2023).

Actual leave encashment received.

Salary for 10 months (based on the average salary of the last 10 months).

Cash equivalent of the leave due (up to a maximum of 30 days for every year of service).

Leave encashment during service is always fully taxable.

Indian citizens between the ages of 60 and 80 can avail tax deductions up to Rs. 3 lakh on yearly income. The following table represents the income tax slabs with the annual income of senior citizens above Rs. 3 lakh (under the old regime), which will help you in tax planning for retirement.

Income Tax Slab

Income Tax Rate

Between Rs. 3 lakh to Rs. 5 lakh

5% plus cess

Rs. 5,00,001/- to Rs. 10,00,000/-

Rs. 10,000/- + 20% of (Total income - Rs. 5,00,000/-) + cess

Above Rs. 10,00,000/-

Rs. 1,10,000/- + 30% of (Total income - Rs. 10,00,000/-) + cess


Super senior citizens aged 80 and above are exempt from tax on income up to Rs. 5 lakh under the old regime. Under the new regime, taxpayers of all ages are exempt from taxes if they have an income of up to Rs. 7 lakh.

Summary

To sum up, tax planning for retirement is extremely important to guard the savings you have accumulated from being eroded by taxes during your post-retirement years. By implementing strategies and optimising your investment portfolio for tax efficiency, you can substantially reduce your overall tax burden. 

You will thus be able to maximise your retirement income benefits with a high level of efficiency and enjoy well-deserved financial security in your golden years. Consider various tax-saving investment options that might be available to achieve your goals.

Frequently Asked Questions

1. How is retirement planning taxed?

The tax amount will differ depending on your age and nature of income. Tax benefits are available to retired individuals on commuted pension, leave encashment, gratuity, PPF, VRS, Savings & Term Deposits, etc.

2. How can a retired person save tax?

A retired person above age 60 can save tax by investing in savings bank accounts, bank deposits, or post office deposits and can benefit from deductions of up to Rs. 50,000 on the interests earned under Section 80TTB. They can also claim income tax deductions under Section 80C and Section 80CCD by increasing their contributions to the Public Provident Fund (PPF) and National Pension System (NPS).

3. Is gratuity taxable on retirement?

Gratuity taxation depends on the employee type.

  • For government employees, it’s fully tax-exempt.
  • For non-government employees under the Payment of Gratuity Act, the least of actual gratuity or ₹20 lakhs or 15 days’ salary for each completed year of service (calculated as the last drawn salary divided by 26, multiplied by 15, and then multiplied by the number of completed years of service) is exempt; excess is taxable.

For non-government employees not under the Act, least of actual gratuity or ₹20 lakhs or half month’s salary for each completed year of service (calculated as the average salary of the last 10 months). is exempt; the remainder is taxed.

4. What is the 4% rule in retirement?

The 4% rule in retirement is quite straightforward, as you must calculate all your investments and withdraw 4% of the total sum in your first year of retirement. After that, you can adjust the amount by following the inflation rate. Hence, by following this rule, you can ensure you will not deplete your funds over 30 years of retirement period.

5. Is the PF amount taxable after retirement?

According to the Income Tax Act provisions, if an amount is withdrawn from the EPF after retirement, it is exempted from any tax. Further, the exemption is provided for the total accrued balance in an employee's EPF account at the time of his retirement or cessation from employment.

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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 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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NOTE - Tax benefits & exemptions are subject to conditions of the Income Tax Act, 1961 and its provisions. Tax Laws are subject to change from time to time. Customer is requested to seek tax advice from his Chartered Accountant or personal tax advisor with respect to his personal tax liabilities under the Income-tax law.

 

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