To Commute Or Not To Commute Your pension?

To Commute Or Not To Commute Your pension?

Commuting part of the pension to get a lump sum can benefit a retired defence personnel in many ways, Here’s How

Though this note is specific for defence personnel's but it is applicable to all persons in government job.

After serving long years in the field, are you looking forward to retiring from the defense services and leading a comfortable retired life? While there are inflation linked pension plans that would replace your salary in your retirement years, there is one problem. You may need some lump sum money to complete your relocation or doing up your retirement home. Or, there could be some other needs, such as the need for some funds to bridge the shortfall for your chid’s marriage. You can solve the problem by commuting your pension, where you would have to forego some part of your future pension for next 15 years and get a lumpsum in return.

Thus for your immediate and near-term needs, you will be foregoing some of the income security of tomorrow. The question is should you make this choice?

Pension Commutation

After commutation, only the basic pension is reduced for retired defence personnel, while they get the dearness allowance benefits on the entire pension amount. After completing 15 years of commutation, the full pension is restored. The other added advantage of commutation is that while your pension would be taxable, the commuted lump sum amount is tax free. It is basically a trade off. If you commute, you obviously get a tax free and lump sum amount that you can use according to your needs and, at the same time your pension amount comes down.

While civilian government employees are allowed to commute a maximum of 40 percent of their pension, defence personnel are allowed to commute upto 50 percent of their pension. However it is mandatory for defense personnel to have at least 20 years of service to be eligible for full retirement benefits. Most personnel join the defense forces at an early age ie; between 18 and 23 years of age. The mandatory period of 20 years of service is completed by the time they turn 38 to 43 years, after which they can enjoy full benefits. Some of the personnel who retire from defense forces after completing this mandatory service period end up taking another government , public sector or even private sector job, adding to their taxable income. Even such people are entitled to pension commutation.

Best for Early Retirees

As the full pension is restored after 15 years of commutation, for personnel opting for early retirement at, say 45 years commutation helps since they get the advantage of full pension by the time they reach 60. As the pension is not tax free, you would have to pay higher taxes after 45 years if you have the higher pension amount. Commutation not only gives you tax free lump sum, but also reduces the taxable pension amount. By commuting you are getting a tax benefit, you have the option to utilize the lump sum and, at the same time, you could be generating a regular inflow, at a slightly better rate.

The most important aspect of pension which decides the lump sum amount is the commutation factor. At an early age the commutation factor is higher and it decreases with increasing age. For example if you commute Rs 10000 when you are 45, you would get a lumpsum of Rs 10.61 lakhs, however at the age of 60 years, you would get only Rs 9.94 lakhs, as early retirement gives you a higher lump sum for the same amount of commutated pension. Many people who retire early might not have completed their life goals, such as purchasing a home, or providing for their children’s education, among others. Here, they have the opportunity to get extra lump sum amount, apart from their other retirement benefits to take care of these goals.

On Regular Retirement

If you decide to retire at a later stage in your life, you may approach the commutation issue differently. Since this is the stage where most people prefer security and stability, commuting pension by taking lump sum and deploying it for generating better returns could be a slightly more risky preposition for them. Taking a call on commutation of pension should be based on the overall amount one receives as the lump sum from all retirement benefit sources and not just based on the commutation amount. However, even the personnel who retire at a later stage, have an edge over their civilian counterpart, as they have the back up of good health care through ECHS and access to subsidised items at military canteens. Apart that, dearness allowance is given to all government pensioners on the full pension amount which takes care of inflationary pressures over the long term. This raises their risk appetite to take the lump sum and deploy it in a manner which could give better future stability, reduce future cost or enhance future lifestyle.

If you want a lumpsum for which you either have some commitment to retire such as an outstanding home loan or you are going to generate higher returns by taking this lump sum and deploying it somewhere else, you should commute your pension. How you use the lump sum amount would depend on the long term objective, rather than splurging it, say on an exotic holiday.

AGE ON NEXT BIRTHDAY	45	50	55	60
BASIC MONTHLY PENSION Rs	20000	25000	30000	40000
PENSION TO BE COMMUTTED (OPTIONAL UPTO 50%)	50%	45%	40%	30%
COMMUTATION FACTOR (BASED ON AGE)	8.996	8.846	8.627	8.287
LUMPSUM AMOUNT Rs (COMMUTED PENSION)	10,79,520	11,94,210	12,42,288	11,93,328
DEARNESS RELIEF SAY IS 90%	90%	90%	90%	90%
MONTHLY PENSION INCLUDING DR AFTER COMMUTATION	28,000	36,250	45,000	64,000

 

Happy Investing

Source:Outlookmoney.com