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How to Build a Tax-Free Pension Income for Retirement?

How to Build a Tax-Free Pension Income for Retirement?
  • 30th Nov 2021 |
  • 815

Once you retire from your professional life, it becomes hard to maintain a regular income stream. Moreover, with increasing inflation, relying only on your savings is not enough. You need additional income to maintain your standard of living. On the plus side, retirement plans can ensure the continuous flow of tax-free pension income when required. Essentially, you can achieve the following by investing in a retirement plan.

1) A sense of self-reliance

2) A relaxed life post-retirement

3) Assured savings

4) Emotional wellbeing

What is a Retirement Pension Plan?

Post-retirement income is provided via retirement plans, which are insurance products. Generally, you pay regular premiums that can be monthly or annual. When you reach retirement age, you start receiving a set monthly payment for the rest of your life, as well as a life insurance policy.

Pension plans offered by insurance firms might include or exclude life insurance. Although, people prefer covered pension plans to safeguard their families from the uncertain events of life.

What is commuted pension?

The term “commuted pension” refers to the lump-sum amount you receive in advance of your income in retirement benefits. Say you wish to take your family on vacation at the age of 60. You will require a one-time payment for that.

Tax on pension schemes

Pensions are a type of life insurance that meets a distinct demand. Pension plans aim to support the individual and his family if he lives on, unlike protection plans (like term plans) which are designed to safeguard the individual’s family upon death financially. The maximum yearly contribution is ₹150,000.

Benefit from taxes: Section 80CCC

The total allowed deduction under all of Section 80C’s sub-sections, including 80CCD and 80CCC, is limited to ₹150,000.

Types of Pension Plans

Various pension plans are available in India. They can all be grouped into the following categories:

1) Sponsored by Insurer

The premium paid for these plans is lent to corporates or banks by the insurer. So, these plans earn income only from the debt securities. Risk-averse people should invest in a sponsored pension plan. You can choose from 2 types of annuity plans here:

a) Deferred Annuity Plan

Under this scheme, you can pay regular premiums until your retirement. Then, post-retirement, you get a steady income to sustain your expenses.

b) Immediate Annuity Plan

You are required to pay a lump sum premium under this scheme. Subsequently, you can enjoy the monthly pension payments immediately after.

2) Unit Linked Pension Plans

These plans invest your premium money mainly in equity. However, they also invest a portion of these funds in debt markets to gain stability. Higher chances of returns imply a higher risk due to stock market exposure. Therefore, investors having a higher risk appetite should opt for these plans.

3) National Pension Scheme

In the wake of the success of private pension plans, the Govt. of India introduced a state-sponsored pension plan in 2004. You receive units as per the NAV of the fund you choose to invest in. You are allowed to withdraw 60% of the corpus upfront post-retirement and purchase an annuity scheme with the remaining 40%.

Taxation of Pension Plans

Is the pension income completely tax-free? Unfortunately, no! Here is the correct tax treatment of pension plans.

1) Premium Paid under Pension Plans

a) Deferred Annuity & NPS

Deferred annuity premiums can be deducted from your taxable income up to ₹150,000 each financial year under Section 80CCC of the Income Tax Act.

b) Immediate Annuity

This plan’s entire premium can be written off as a deduction in the same fiscal year. This is done to protect investors’ interests, as this scheme has only one lump sum premium.

2) Pension payments post-retirement

a) Commutation

You can withdraw 1/3rd of the entire corpus at once after retirement. Tax on this amount is exempt under Section 10(10A) of the Income Tax Act.

b) Monthly Pension

Tax is levied based on your slab rates for the monthly pension that you earn.

The calculation of retirement taxes

Rent from real estate, capital gains from investments, and interest are all ways you can make money even if you don’t have a steady paycheck. Those who receive the commuted money must pay taxes on half of it if gratuities are included. In the event that gratuities are not given, one-third of the commute is tax-free.

The taxation depends on whether you receive a lump sum amount (commuted pension) or instalments spread over a period of time (non-commuted). In the event that you do not receive gratuities, one-third of the commute is tax-free. But the non-commuted pension is considered a salary and is taxable under the current tax rates.

Pay off debts before you retire

Personal loans, credit card balances, and auto loans are examples of high-interest debts that do not provide any tax advantages. The EMIs eat into your corpus.

It will enable you to pay all of your living expenses out of your income. You could thus keep up your desired quality of living with a low tax rate.

Plan your expenses

Most significant out-of-pocket costs will have likely been paid by the time you retire. You would have already purchased a home or paid for your children’s college. Therefore, now is the perfect moment to review your daily costs. Monitor your monthly spending. Spending money on utilities and groceries. Use credit cards only seldom.

Choose the right investment options

Select the appropriate investment tools to take advantage of the tax rules’ exemptions and deductions. You must make investments in securities with tax-free maturity amounts. Think about the following investing possibilities:

Invest in savings accounts, as well as deposits with banks or the post office. Can get deductions for interest earned under Section 80TTB of up to ₹50,000.

Use extended contributions to the Public Provident Fund (PPF) and National Pension System to qualify for Section 80C and 80CCD rebates (NPS).

By investing in ULIPs designed specifically for retirement, you can reduce your taxes and benefit from Section 10(10D)* tax relief on the maturity amount. You can earn inflation-adjusted returns through capital market investments using these long-term goal-based investing channels. However, with balanced funds, your equity exposure is reduced.

The monthly pension amount you can earn depends on the size of your invested corpus and the returns thereof. Hence, investing in pension plans early can help you save longer and earn more. So explore the best pension plans online and start planning your retirement now.

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