Pension is the portion set aside from an employee's salary, which is paid out periodically, usually on a monthly basis. The Taxpayer can also opt to receive his pension as a lump sum which is called commuted pension. A periodically paid pension is called uncommuted pension. The source of pension income is usually an annuity fund that the employer and the employee create during the service period. The annuity fund invests the contributions and pays out the pension to the employee after retirement.
The taxation of pension income depends on whether it is commuted or uncommuted. An uncommuted pension is taxed as salary income in the hands of the employee. Commuted pension is partially exempt from tax depending on the type of employee. Commuted or uncommuted pension is exempted from tax in case of government employment. In the case of a non-government employee, a pension is partially exempt depending on whether the employee receives the gratuity.