How do I avoid paying high taxes on pension income?

Retirement is supposed to be the "Golden Age," but for many, it becomes the "Taxable Age."
You spent 30 years paying taxes on your salary. Now, when you finally start living off your savings, the government asks for a share again.
Most retirees make the mistake of buying an Immediate Annuity with their entire corpus.

• Scenario: You invest ₹1 Crore in an annuity plan.
• Income: You get ₹6 Lakh/year.
• Tax: This ₹6 Lakh is added to your other income and taxed at your slab rate.
  

But you don't have to accept this default setting. By using the 2025 Tax Rules smartly, you can legally slash your tax bill.
Here is your guide to keeping more of your hard-earned pension.

The short answer: Don't take it all as "Salary"

If you receive your entire retirement corpus as a monthly annuity (pension), it is fully taxable as salary, which can push you into a 30% tax bracket. The secret to lowering tax is Structural Planning:
1.Commute the maximum allowed portion (usually 60%) as a tax-free*** lump sum.
2.Invest that lump sum into a Systematic Withdrawal Plan (SWP) in Mutual Funds.
   ○ Result: Instead of paying 30% income tax on your pension, you pay roughly 5-8% effective tax (Capital Gains) on your SWP income.
Strategy 1: The "Commutation" Hack (The 60% Rule)
"Commutation" means withdrawing a part of your pension corpus as a lump sum upfront, instead of taking it as monthly income.

• For NPS / Pension Plans: You can withdraw up to 60% of your total accumulated corpus tax-free***.
• For Gratuity-Linked Pension:
  

   ○ Government Employees: 100% of commuted pension is tax-free***.
   ○ Private Employees: 1/3rd of the pension (if you get gratuity) or 1/2 (if no gratuity) is tax-free***.
The Strategy:
Always commute the maximum permissible amount.

• Why: A lump sum in your hand is tax-free***. A monthly pension from that same money is taxable.
• Action: Take the 60% out. Invest it separately (see Strategy 2). Only use the remaining 40% to buy the taxable annuity.
  

Strategy 2: The SWP Route (Income vs. Capital Gains)
This is the most powerful tax-saving tool for retirees in 2025.
Instead of buying an annuity that gives you taxable "interest," invest your commuted corpus in a Debt Mutual Fund or Conservative Hybrid Fund and set up a Systematic Withdrawal Plan (SWP).
Why SWP wins on tax:

• Annuity/FD: The entire payout is taxed.
• SWP: You are withdrawing your own capital back. Only the profit portion is taxed.
• Example: You withdraw ₹50,000/month.
  

   ○ In the early years, ₹45,000 is your principal (tax-free***) and only ₹5,000 is profit.
   ○ You only pay tax on that tiny ₹5,000 profit.
Effective Tax Rate:

• Annuity: 30% (if you are in the highest slab).
• SWP: Often less than 5-10% of the total withdrawal amount.
  

Strategy 3: Utilize "Senior Citizen" Deductions
The Income Tax Act offers specific buffers for seniors (Age 60+) that you must utilize before paying a single rupee of tax.
1.Standard Deduction:
   ○ As of FY 2025-26, pensioners are eligible for a Standard Deduction of ₹75,000.
   ○ Benefit: The first ₹75,000 of your pension income is straightaway tax-free***.
2.Section 80TTB (Interest Income):
   ○ Standard citizens get no deduction on FD interest.
   ○ Senior Citizens get a ₹50,000 deduction on interest from FDs, Savings Accounts, and Post Office schemes.
   ○ Strategy: Ensure your FD interest stays within this limit to enjoy tax-free*** returns.
3.Section 80D (Medical Insurance):
   ○ Seniors can claim up to ₹50,000 for health insurance premiums.
   ○ Hidden Gem: If you don't have insurance, you can claim this ₹50,000 for medical expenses (bills for medicines/doctors) provided you have no health policy.
Strategy 4: Income Splitting (The Spouse Strategy)
If your spouse has no income or falls in a lower tax slab, do not invest everything in your own name.

• The Move: Gift money to your spouse.
• The Rule: While income from gifted money is usually "clubbed" with your income, if you invest in tax-free*** instruments (like PPF in spouse's name) or huge long-term growth assets, you can manage the clubbing provisions or use the "pin money" allowance.
• Better Route: Invest in a Joint Life Annuity. The income comes to you first. After your death, it goes to your spouse. Since your spouse likely has no other salary, this pension might fall in the zero-tax bracket for them.
  

Strategy 5: New vs. Old Tax Regime
For retirees in 2025, the New Tax Regime is often the winner.

• Rebate Limit: Income up to ₹12 Lakh is effectively tax-efficient under the New Regime due to higher rebate limits and standard deduction.
• No Investment Headache: You don't need to lock money in Section 80C instruments just to save tax. You can keep your money liquid. Check: If your total pension income is under ₹12 Lakh, you might pay zero tax just by switching to the New Regime.

Summary Checklist: Your Tax-Saving Plan

Final Thoughts

You cannot avoid taxes entirely, but you can choose which tax to pay.

• Paying Income Tax (30%) on pension is expensive.
• Paying Capital Gains Tax (12.5% LTCG) on investments is cheap.
  

Shift your retirement income from "Pension Products" to "Investment Products" (like SWP) wherever possible.
At ABSLI, we often recommend customers to take the tax-free*** Lump Sum options in our pension plans and only annuitize what is mandatory. This keeps your money flexible and your tax bill low.