Planning for retirement with smart savings

Saraswathi Kasturirangan | Updated on October 14, 2012 Published on October 14, 2012


Middle- to senior-level employees often opt for enhanced contribution to retirement plans — and the availability of tax relief could be an influencing factor.

Managing retirement benefits is similar to running a marathon — more so in the absence of a strong social security system. Retirement benefits may be in the form of defined contributions or benefit plans; hence the method of accrual, mode of withdrawal and tax impact vary. Mandatory retirement benefits include gratuity, Provident Fund (PF), and pension as governed by the Employee Pension Scheme (EPS). Superannuation schemes and, of late, the New Pension Scheme (NPS) introduced by the Central Government have generated interest.

An employee with not less than five years of continuous service is eligible for gratuity on retirement, superannuation or resignation. However, the service period requirement does not apply when there is termination of service following death or disability due to accident or disease.

According to the Payment of Gratuity Act, gratuity of 15 days’ wages should be paid for every completed year of service, or part thereof when exceeding six months.

It is based on the last drawn wage of the employee. Some company policies may be more beneficial to the employee, but the tax exemption is limited to Rs 10 lakh over the service period.

Contribution to PF is attractive in terms of return and tax relief. Employees are mandated to contribute 12 per cent of pay. They can opt to restrict the quantum of pay to Rs 6,500 a month or opt out of the scheme when pay exceeds that amount. The employer has to make a matching contribution. While the employer’s contribution (up to 12 per cent of pay) is tax exempt, the employee’s contribution is eligible for deduction up to Rs one lakh a year.

The PF balance is accumulated in the employee’s name; it currently earns interest at 8.25 per cent (based on government approved rates) and is tax exempt. As the interest rate is not market determined, it is generally considered a sound investment.

The PF balance is available for withdrawal upon retirement, or under specified circumstances. Loans (both refundable and non-refundable) are available for prescribed purposes against the accumulation. There is no tax implication on withdrawal if the employee has five years of continuous service.

A part of the employer’s contribution (8.33 per cent of pay, limited to Rs 6,500 a month — that is, Rs 541 a month) is allocated to the Employee Pension Scheme. This entitles the employee to a monthly retirement pension, computed by multiplying the pensionable salary with the pensionable service period and dividing by 70. Pension received is taxable.

Many companies have superannuation schemes for employees whereby an agreed percentage of pay or a specified amount is contributed by the employer to an approved scheme.

There could be employee contribution as well. Generally the fund is managed by annuity service providers such as LIC, and the employer’s contribution up to Rs one lakh a year is tax exempt. Tax exemption is also available for commutation of annuity on retirement and payment to beneficiary on death of employee.

The NPS, regulated by the Pension Fund and Regulatory and Development Authority (PFRDA), has been extended to non-government employees since 2009. It has the flexibility of choosing the pension fund manager, the investment mix, and contribution amount, subject to minimum contribution of Rs 6,000 a year. With a nationwide unique identification number, continuity is assured even when there is change in employment. Returns are market-driven, and the net asset value is published daily.

Withdrawal is generally permissible at the age of 60, and there are guidelines on lumpsum withdrawal and retention of fund for annuity. The employer’s contribution to NPS is tax exempt up to 10 per cent of salary, making it an attractive scheme.

Employee contributions are entitled to deduction, along with other investments, with the overall limit at Rs one lakh in a tax year. There is no specific exemption under the Income Tax Act for annuity received under NPS; however, the Direct Taxes Code proposes to exempt it.

While those in the younger age group may prefer a higher take-home pay, middle- to senior-level employees opt for enhanced contributions to retirement plans.

Various factors such as salary level, cash take-home, and inclination towards retirement planning influence this decision; and, the availability of tax relief could be a contributing factor too.

Saraswathi Kasturirangan is Senior Manager, Deloitte Haskins & Sells

Published on October 14, 2012
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