Tax Imposed on the Retirement Benefits of an Employee

September 26, 1960 BIR RULING NO. 438-60 The Insular Life Assurance Co., Ltd. Insular Life Building M a n i l a Gentlemen : This is in answer to your query on whether retirement benefits of an employee should be included or excluded from his gross income where said benefits are paid in accordance with the retirement plan which you described as follows: LLjur "In consideration of certain premiums, "Y" Company agrees and undertakes to pay each of the employees of "X" Company, upon his or her retirement at age 60, a monthly income benefit for as long as he or she lives. Under the agreement, the retirement plan is contributory, the employee contributing 2.7% of his monthly salary to the monthly premiums and the employer assuming the balance of the cost of the plan. The contributions of the employee and the employer are used to purchase separate amounts of monthly income. For example, an employee aged 25 upon his inclusion in the retirement plan and getting a monthly salary of P300.00 (which we assume constant up to his retirement) had "Total contributions: "a. Paid by employee P3,402.00 "b. Paid by employer 6,163.85 Total P9,565.85 "Total monthly retirement income: "a. Purchased by employee's contributions P38.40 "b. Purchased by employer's contributions 103.35 P141.75 "Total lump sum settlement: "a. Equivalent of incomes purchased by employee's contributions P6,580.26 "b. Equivalent of incomes purchased by employer's contributions P13,795.98 Total lump sum settlement P20,376.24 ========= "As an option, a retiree may elect a lump sum settlement instead of the monthly incomes, but such option may be elected only at least five (5) years prior to his retirement; otherwise, the election for lump sum settlement shall be subject to (1) his passing a medical examination and (2) the approval of "Y" Company. The employee who retires without previously electing lump sum settlement shall receive only the stipulated monthly incomes, and in the event of his subsequent death, no further monthly incomes shall be payable, but the balance, if any, of the total contributions of the employee, after deducting the total monthly incomes already paid to him before his death, shall be paid in one lump sum to the beneficiary designated by the employee. Such payment to the beneficiary does not include any amount corresponding to the balance if any, of the contributions paid by the employer." Let us consider first the retirement benefits paid in lump sum. In the example given above, the total contributions paid by the employee is P3,402.00. This amount shall not be included in his gross income. But, the difference between the "total lump sum settlement" and the total contributions paid should, of course, be declared for income tax purposes. Hence, in the same example, since the total lump sum benefits is 20,376.24, the employee should declare in his income tax return the amount of P16,974.24. We now come to the retirement benefits paid monthly. In the above example, the monthly contribution of the employee is P8.10 or P97.20 a year and his monthly retirement income is P141.75 or P1,701.00 a year. In this case, the amount representing the total contribution for the year which is P97.20 shall not be included in his gross income. This amount shall be deducted from the total of the monthly benefits received during the year which is P1,701.00 and the difference which is P1,603.80 shall be declared for income tax purposes. When the yearly deductions (P97.20) shall have reached the total contributions paid (3,402.00) by the employee, the entire monthly benefits received shall be subject to income tax. In fine, the rule may be stated that under the retirement plan described by you, only that portion of the retirement benefits representing the contributions paid by the employee are exempt from the income tax, whereas, the rest are subject. Very truly yours, MELECIO R. DOMINGO Commissioner of Internal Revenue