How does superannuation work?

Superannuation generally works by accumulating contributions during an employee's working years to provide retirement benefits later. It has four key elements:

1. Contributions
   Employers typically contribute up to 15% of an employee's basic salary plus dearness allowance as part of the employee's retirement benefit. Employees may also voluntarily contribute to the fund, although employee contributions to superannuation are uncommon.
2. Investment
   Superannuation funds are managed by insurance companies or authorised trust organisations, which are responsible for investing the money in accordance with the applicable investment guidelines.
3. Eligibility and vesting period
   Employees have to comply with the applicable vesting conditions before the superannuation benefit becomes payable. They may need to complete a specified period of service, generally five years, before they become eligible to receive the benefit.
4. Payout
   Employees are allowed to withdraw a portion of the accumulated corpus upon retirement. The remaining amount is used to purchase an annuity, which is designed to provide regular income during the post-retirement period, depending on the policy.

What are the different types of superannuation plans?

Broadly, there are two types of superannuation plans: defined benefit plans and defined contribution plans. While both plans are designed to provide financial support during retirement, they differ in their contribution and payout structures. The type of plan available to employees depends on the employer.

Defined benefit plans

As the name suggests, the benefits are predefined in the case of defined benefit plans. The retirement benefit is calculated using a predetermined formula, which may consider factors such as the employee's salary, years of service and age at retirement.

Once the benefit is determined, the employer must provide it, irrespective of the fund's investment performance. Therefore, the employer generally bears the investment risk. Such plans are suitable for employees who seek greater income certainty during retirement and prefer to avoid investment risk.

Defined contribution plans

As the name suggests, the contribution is defined in the case of defined contribution plans. The employer contributes a predetermined amount to the fund, often on a regular basis. However, the final retirement benefit is not fixed and may depend on factors such as the contribution amount, the period of investment and the fund's performance. Therefore, the employee generally bears the investment risk. Such plans may be suitable for employees who are comfortable taking investment risk in pursuit of market-linked growth.

What are the income tax benefits of superannuation?

Superannuation is not only a useful retirement option but may also offer tax benefits, provided the scheme is approved by the Commissioner of Income Tax and meets other applicable conditions. Moreover, the tax benefits are not just extended to the employee but can also be claimed by the employer, subject to the relevant rules.

Superannuation tax benefits for the employer

Employers may claim deductions for contributions made to the superannuation fund, subject to the applicable tax rules and limits. This can help them reduce their business' taxable income and retain more of their profits.

Superannuation tax benefits for the employee

• Employees making voluntary contributions to the fund can claim a tax deduction of up to ₹1.5 lakh per financial year under the old tax regime
• Interest accrued on the superannuation fund balance is generally exempt from tax, subject to the applicable rules
• Certain payments from an approved superannuation fund on retirement or due to incapacity may be exempt from tax, subject to the applicable conditions. For other payments, the tax treatment depends on the circumstances and applicable rules
• Payments made to a nominee on the death of the beneficiary are also tax-free
• If the employer's aggregate contribution to an approved superannuation fund, National Pension System (NPS) and recognised provident fund exceeds ₹7.5 lakh in a financial year, the excess amount is taxed as a perquisite in the hands of the employee
• The amount withdrawn on changing jobs may be taxable, depending on the circumstances. Tax may be deferred or avoided where the benefit is transferred in accordance with the applicable rules

What is the difference between superannuation and retirement?

Superannuation and retirement may be related concepts, but they are conceptually two different things.

Retirement is a life phase that marks the end of an individual's working years. It also marks the transition from earning regular income to relying on other sources of income. While the traditional retirement age is generally 58 to 60 years, individuals may choose to retire earlier depending on their aspirations and financial circumstances. Retirement can be funded through savings, investments and other sources of income, giving individuals greater control over their financial planning.

Superannuation is a retirement benefit scheme that helps provide financial support to individuals during or after retirement. The fund is mostly employer-sponsored, with employees having the flexibility to contribute, depending on the scheme. The contributions and payouts depend on the structure and type of scheme. Superannuation can form part of retirement planning alongside other financial products, such as fixed deposits, pension plans and life insurance.

To sum it up, the superannuation and retirement difference can be understood simply as follows: retirement is a life stage, while superannuation is one of the ways to build financial resources for retirement.

Conclusion

The answer to what is superannuation may be of importance to an individual's retirement planning journey. It is an employer-sponsored retirement benefit scheme designed to help employees support their post-retirement financial needs. It may not only be tax-efficient for employees but may also offer tax benefits to employers.