The 411 on retirement benefits

LAWS granting benefits to retiring employees have been around for decades, but up to now, there is still confusion as to how these benefits, as well as the corresponding expenses, should be treated for tax purposes.

Last Jan. 22, 2024, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Circular 13-2024 to shed light on some of these issues.

As a general rule, retirement benefits received by a retired employee are considered compensation income subject to tax. This rule, however, is not without exceptions. Under Republic Act (RA) 4917, benefits granted to these employees under a tax-qualified plan are exempt from tax if the retiring employees meet the following criteria:

– the retiring employee is at least 50 years of age and has served the employer for at least 10 years; and

– the employee has not previously availed of the privilege under a retirement benefit plan of the same or another employer.

In addition, where the employee does not have a qualified retirement plan, RA 7641 provides that if the retirement benefit is received by a qualified employee, such is exempt from income and withholding tax if the following are present:

– the retiring employee is at least 60 years of age but not beyond 65 years, which is declared the compulsory retirement age;

– the employee has served the employer for at least five years, which includes authorized absences and vacations, regular holidays, and mandatory fulfillment of military service; and

– the employee has not previously availed of the privilege under a retirement benefit plan of the same or another employer.

For an employee who is asked by the employer to stay on and eventually retires past the age of 65, the BIR clarified that the benefits granted to such employee are still not subject to income tax as long as the employee has served the employer for at least five years and has not previously availed of the privilege under a retirement benefit plan of the same or another employer.

It is another matter in case a qualified employee retires at the age of 65 and receives retirement benefits, tax-free, and is subsequently re-hired by the employer. In this particular situation, all income and other benefits received by the employee beyond the age of 65 shall be considered compensation income subject to tax and, consequently, to withholding tax.

On the part of the employer, the question often raised is whether retirement benefit expenses incurred by employers can be claimed as a deduction for corporate income tax purposes. This would depend on whether the employer has a tax-qualified plan, which is a retirement benefit plan registered with the BIR pursuant to RA 4917, and declared as reasonable under pertinent provisions of the Tax Code.

If the employer has a Tax-Qualified Plan, which is evidenced by a certificate of tax qualification issued by the BIR, the employer may deduct the following contributions to the retirement fund:

– contributions to the retirement fund during the taxable year to cover the pension liability accrued during the year (“normal cost”); and

– contributions to the fund during the taxable year in excess of the normal cost but only if such amount has not before that been allowed as a deduction and is apportioned in equal parts over a period of 10 consecutive years beginning with the year in which the transfer or payment is made.

In case there is no tax-qualified plan, the employer can only claim the actual amount of retirement benefits paid to retiring employees as deduction from its gross income.

Another question often posed by employers involves the taxability of income earned from investing the employee retirement fund. The BIR explained that the income of the retirement fund from its investments is exempt from income tax provided all statutory requirements for a reasonable retirement benefit plan are met and complied with pursuant to the provision of the tax code. Moreover, a tax-qualified plan may invest its funds without losing its tax-exempt status, provided that the funds are not actually used or diverted to purposes other than for the exclusive benefit of the employees or their beneficiaries.

The retirement of an employee is an important milestone as it marks the end of one career and the beginning of a new chapter in the life of an employee. It is only right that the government does its share in honoring the service, dedication, and hard work of every employee come retirement time by providing tax exemptions to benefits received and giving tax breaks to employers as a way of encouraging them to provide the best possible retirement package to their loyal employees.

The author is a senior manager with the Tax & Corporate Services division of Deloitte Philippines, a member of the Deloitte Asia Pacific Network. For comments or questions, email [email protected].