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Commutation amount refers to the lump sum portion of a retirement corpus that can be withdrawn at the time of retirement instead of receiving it as regular periodic payments. In many pension or retirement plans, a portion of the accumulated fund can be commuted or taken as a one-time payment, while the rest is used to provide regular pension or annuity income.
The process of commutation is often called commutation of pension, where you exchange part of your future pension for an upfront lump sum.
What is a Commuted Pension?
The annuity fund that generates your pension at retirement is partly funded by your organisation and yourself. When you retire, you can choose either of two methods to receive the accumulated amount:-
1. As pension paid on a monthly basis
2. As an advance lump sum amount
A commuted pension is an advance amount that you get as a lump sum and which is deducted from your total pension fund. This helps answer the question of what is commuted pension and clarifies that it is different from receiving the entire pension as periodic payments.
For instance, you may want to take your family on a trip once you're sixty years old. You'll require a lump sum payment for this purpose.
You can choose to get an advance of 20% of your monthly pension of Rs. 25,000 for the next five years. The total will be computed as follows and paid to you as a lump sum amount:
20% of 25,000 × 12 × 5 = Rs 3,00,000. This amount is your commuted pension.
This process is known as commutation of pension and is a common feature in many retirement plans.
Rule of Commuted Pension
Here are the key provisions that you should keep in mind:
- A government employee may commute up to 40% of a base pension in one lump sum payment under Rule 5 of the CCS (Commutation of Pension) Rules, 1981.
- Rule 10 mandates that the applicant will receive the difference between the authorised and increased commuted pension if the government modifies or increases a pensioner's benefits after commutation.
How to Calculate Commuted Pension
Three main inputs used in commutation of pension calculation are the percentage of your pension you want to take as a lump sum, your monthly pension amount, and the commutation factor which is a number decided by the government based on your age at retirement.
Pension Commutation Formula:
Commuted Pension = (Portion of Monthly Pension to Commute × Monthly Pension Amount × Commutation Factor × 12)
Example:
If you get ₹45,000 per month as pension, want to commute 35% of it, and your commutation factor is 9.12:
₹45,000 × 35% × 9.12 × 12 = ₹17,25,120
This ₹17,25,120 is the lump sum amount you’ll receive under the commutation of pension rules. The remaining pension will be paid to you every month.
How to Calculate Pension Commutation Deduction
- Here are the steps to calculate a pension commutation deduction:
- Multiplying the commuted amount by itself and by 12 yields the total commutation amount. You can use a pension commuted value calculator for this purpose.
- Based on age-related considerations and commutation laws, the commuted amount is calculated by dividing the pension amount by the commuted percentage of the pension.
Taxation on Commuted Pension
The commuted pension taxability depends on your employment type, gratuity eligibility, and in some cases, special exemptions.
Government Employees
For government employees, the entire commuted pension amount is fully exempt from income tax under Section 10(10A) of the Income Tax Act. This commuted pension exemption means retirees can access the lump sum without tax deductions. Families of members of the armed forces and employees of the United Nations Organisation (UNO) are also fully exempt from paying tax on their pensions.
Private Sector / Non-Government Employees
Taxability for private employees depends on whether gratuity is received:
If gratuity is received: One-third of the commuted pension amount is tax-free, while the remaining portion is taxable as per the individual’s income tax slab.
If gratuity is not received: Half of the commuted pension amount is tax-free, and the rest is taxable.
Special Exemptions for Family Members
Family members of a deceased employee may be eligible for tax exemptions of up to ₹15,000 or one-third of the pension amount in a fiscal year, whichever is lower.
Other Considerations
If the commuted pension received exceeds the maximum tax-exempt limit, the excess is fully taxable in that assessment year. However, if Form 10E is submitted, Section 89 of the Income Tax Act allows certain tax relief on the commuted pension amount. Using a pension calculator can help in planning commutation and understanding the overall tax on commuted pension.
Commuted Pension Exemption Under Section 80C
Pensioners are eligible for a tax exemption of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. Exemptions of Rs. 2 lakh can also be claimed under several categories if one is 60 years of age or older. These are some of the investment options that are tax-exempted under this section:
Fixed Deposit
Tax-saver fixed deposits are a good choice since they can get you deductions up to Rs. 1.5 lakh under Section 80C. However, they have 5-year lock-in periods, although the interest rates are sometimes higher for senior citizens.
ELSS
Equity-linked savings schemes (ELSS) are also tax deductible up to Rs. 1. 5 lakh under Section 80C. They have a 3-year lock-in period while offering higher returns in comparison to many other investments (the risks are also proportionately higher in this case).
Pension Plan Investments
Life insurance companies' pension plan schemes are also eligible for Section 80C deductions, making them good choices for retirees.
Senior Citizen Savings Scheme
This is an excellent method for converting your taxable commuted pension to a sum that is tax-free. You will also get interest as cash flow from the deposit simultaneously. Thus, you may convert a taxable commuted pension at a rate of Rs. 1.5 lakhs per year (if you can budget for around three to five years).
ULIP
You may profit from both investing opportunities and insurance with a suitable ULIP plan. A portion of your contribution is allocated to insurance, with the remaining portion going towards the investment bucket. You are entitled to a tax deduction under Section 80C for the premium investment you make throughout a fiscal year.
Difference Between Pension Payment and Commutation
Pension payments are defined as regular (usually monthly) and periodic payments, while commutation refers to the withdrawal of a lump amount from the commuted pension. Pension payments continue until death, whereas for government employees, commutation permits the withdrawal of up to 40% of the pension in one single amount. In simple terms, commute pension meaning is the option to receive part of your pension upfront as a lump sum instead of monthly installments.
Do You Need to File an ITR for Commuted Pension?
You must file an Income Tax Return (ITR) if the commuted pension amount you receive is higher than the tax-exempt limit. In such cases, the excess amount is fully taxable. To claim tax relief on commutation of pension, you should submit Form 10E, as Section 89 of the Income Tax Act allows certain relaxations.
A commuted pension can be helpful in meeting urgent financial needs since it provides a lump sum. However, because part or all of it may be taxable (depending on your employment type and gratuity eligibility), it’s important to check the exemption limits before deciding.
For an uncommuted pension (regular monthly payments), filing ITR 1 is mandatory since the entire amount is taxable.
Factors to Consider Before Choosing a Commuted Pension
Financial Situation – Review your current savings and other income sources to see if you can comfortably manage with a reduced pension.
Medical Expenses – Set aside funds from the lump sum to cover rising healthcare costs in the future.
Outliving Your Savings – Plan your spending and investments carefully to ensure your lump sum lasts throughout retirement.
Modified Pension Income – Commuting your pension will reduce your monthly income, so ensure the remaining amount can cover your essential expenses.
Tax Implications – Know how much of your commuted pension will be taxable to avoid unexpected tax liabilities.
FAQs
Is the commuted value of the pension taxable?
Pension commutation taxation is contingent upon various criteria, including the form and source of the pension.
Do you need to file an ITR for commuted pension?
If the amount of your commuted pension exceeds the authorised value, you must file your ITR. The additional amount that you get is subject to full taxation. However, note that Section 89 of the Income Tax Act enables more flexibility in these scenarios. In order to take advantage of this tax break, complete Form 10E and report your commuted income while submitting your ITR for any given year.
What is the minimum limit for commutation of pension?
There is no fixed minimum limit for commutation of pension. It depends on the pension scheme and employer’s rules. For central government employees, the maximum allowed is up to 40% of the basic pension, and you can choose any lower percentage.
Which is better, commutation or full pension?
Commutation is better if you need a lump sum amount for immediate expenses or investment. Full pension is better if you want a steady monthly income for life and more financial security.
What is the meaning of commuted pension?
A commuted pension means taking part of your pension as a one-time lump sum instead of getting the full amount every month. The remaining pension is paid monthly.
What is the commuted value of a pension?
The commuted value of a pension is the lump sum amount you receive after opting for commutation. It is calculated using your monthly pension, the percentage you commute, and the commutation factor based on your age.
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