Superannuation – How It Works, Types And Tax Benefits

Superannuation, or a company pension plan, is a retirement benefit plan provided by a company. Employers and employees contribute a fixed percentage of basic salary into a fund to create a corpus and financial stability for employees upon retirement. This fund is paid out on retirement, death, or resignation of employees. It is designed to ensure financial security for employees post-retirement. Also, contributions to superannuation by employees are a tool for tax benefits.

In this article, we will understand the superannuation benefit, which is to help individuals have better financial planning and plan retirement efficiently.

What is Superannuation Benefit?

The dictionary meaning of the word ‘superannuation’ or ‘superannuate’ is to become retired, to retire because of age or infirmity. A superannuation benefit is a retirement benefit offered by employers to their employees. Superannuation is an organisational pension program created by a company for the benefit of its employees. It is also referred to as a company pension plan.

Types of Superannuation Benefit

Superannuation benefit is classified into the following in India based on the investment and benefit it offers:  

Defined benefit plans 

As the name itself suggests, in this kind of superannuation, the benefit derived is already fixed irrespective of contribution to the plan. The pre-determined benefit is based on various factors such as the number of years of service in the organisation, salary, and age at which the employee starts reaping the benefit. This is comparatively complex, and the risk of generating such a benefit lies on the employer. Upon retirement, an eligible employee receives a fixed amount which is determined by the pre-existing formula, at regular intervals.

Defined contribution plans 

This superannuation benefit is opposite to the defined benefit plan. While in case of a defined benefit plan, the benefit is fixed and pre-determined, a defined contribution plan has a fixed contribution and the benefit is directly correlated with the contribution and market forces. This type of benefit is better to manage, and the risk is with the employee as he does not know how much he will receive at retirement.

How does Superannuation Work?

The employer contributes to a superannuation benefit for/on behalf of employees towards the group superannuation policy held by him. 

Organisations either manage superannuation funds by their own trusts, open a superannuation benefit fund with any of the approved insurance companies or buy the product from insurance companies like LIC’s New Group Superannuation Cash Accumulation Plan or ICICI’s Endowment superannuation plans etc. 

The employer contributes a fixed percentage (up to a maximum of 15%) of employees’ basic pay and dearness allowance, and the same percentage of contribution needs to be made for a particular category of employees. Though contribution is made by the employer ideally. superannuation is part of the Cost To Company (CTC). 

It may also be noted that employees may also voluntarily contribute an additional amount to the fund in case of defined contribution plans. At the time of retirement, the employee can withdraw up to 1/3rd of the accumulated benefit and convert the balance into a regular pension, which is in turn kept in the annuity fund for receiving annuity returns at chosen intervals. 

In case the employee changes his job, he has an option to transfer the superannuation amount to a new employer. In case the new employer does not have a superannuation scheme, the employee may either choose to withdraw the amount or retain the amount in the fund till retirement and withdraw as discussed above.

Types of Annuity Options Available

Common annuity options available are:

• Payable for life;
• Payable for life guaranteed for 5 yrs/10 years/15 years;
• Payable for life with a return of capital;
• Payable jointly on the life of husband and wife.

Difference between Retirement and Superannuation

The terms retirement and superannuation are used interchangeably but there is a difference between them. Let’s see how they differ.

• As discussed above, employers create a superannuation fund through their trust, open a fund with approved insurance companies, or buy a product from them. Both employers and employees make periodic contributions to this fund. The accumulated funds can be used at retirement. 
• Retirement is the phase of life where one shifts from a professional life to a phase of rest because of factors like age. After retirement, the person does not work and relies on their savings, pension schemes and other sources of income.
• In a nutshell, Retirement is a phase of your life when you don’t work, and superannuation helps you to receive regular income post-retirement.

Income Tax Benefits

Like any other retirement benefit, superannuation benefit also provides income tax benefits to both employer and employee. However, such benefits are restricted to an approved superannuation fund. This approval is required to be obtained from the Commissioner of Income Tax in accordance with the rules set out in Part B of the Fourth Schedule of the IT Act.

For the Employer
Contribution to an approved (by income tax department) superannuation fund is deductible business expense, and any income received by self-managed trusts of an approved superannuation fund is also exempt.

For the Employee

• Employee’s contribution to the approved superannuation fund is deductible under Section 80C, subject to an overall limit of Rs 1,50,000.
• Employer’s contribution of up to Rs 1.5 lakh in respect of an employee is exempt. However, if the contribution exceeds Rs 1.5 lakh, the amount in excess will be taxable in the hands of the employee as a perquisite.
• The budget 2020,  announced a combined upper limit of Rs 7.5 lakh in respect of the employer’s contribution to NPS, RPF, and Superannuation fund in a year. That means any contribution made by the employer in excess of Rs 7.5 lakh will be taxable as perquisites in the hands of the employee.
• Consequently, the interest, dividend or any other income accumulated on such funds or amount in the financial year shall also be treated as perquisite to the extent it relates to the employer’s contribution, which is added to his total income.
• The amount withdrawn, if any, by the employee at the time of change of job is taxable under the head “Income from other sources”
• Any benefit received from the superannuation fund on death or injury is tax-free.
• Interest from a superannuation fund is tax-free.
• On retirement, 1/3 of the commuted fund is fully exempt from tax, and the remaining amount, if transferred to an annuity, is tax-free, and if the amount is withdrawn, it is taxable in the hands of the employee.

Related Articles:

Deductions Allowed Under Section 80

80C Deductions