Tax Advantages of a Retirement Plan

Since Republic Act (RA) 7641, also known as the Retirement Pay Law, does not require companies to set up formal retirement plans, why, then, should the consider doing so? The answer is very practical in nature: to enable both the company and the employee to avail of the tax advantages that exist only in conjunction with a retirement plan formally filed with the Bureau of Internal Revenue (BIR). An important point to note here is that the applicability of tax benefits is the fundamental difference between a plan filed with the BIR and one that is not.

Some distinct tax advantages of a tax-qualified plan as prescribed by RA 4917 are as follows:

  • Retirement benefits paid to qualified employees are tax-exempt, subject to certain conditions;
  • Contributions to the retirement fund are a tax-deductible expense for the company;
  • The earnings of the retirement trust fund are tax-free; and
  • Systematic build-up of future obligations under RA 7641.

The tax advantage gained by an employee, assuming the necessary conditions are satisfied, is clear in the following example: Given a benefit based on 20 years of service, the income tax payable on the corresponding earnings would correspond to nearly 7 years of service. The difference between tax-exempt and taxable benefits is thus undeniably significant to the employee. Note that the benefit of an employee who voluntarily resigns from the company will always be taxable, regardless of his age and years of service upon voluntary separation.

In the same light, the tax advantage a company gains by registering a retirement plan with the BIR is obvious: contributions to the plan are a tax-deductible expense, which means the taxable income of the company may be significantly reduced.

Finally, retirement trust funds are not subject to the usual 20% withholding tax, which means the fund grows faster and reduces, to some extent, the contributions required from the company to build up the fund.

Note that a key requirement of the BIR for a retirement plan to be tax-qualified is that the retirement fund must be held in trust – with the direct result of the retirement trust fund becoming a legally separate entity from the Company.

ABOUT THE AUTHOR

Raymund Zalamea

Raymund has over 20 years of experience in retirement consulting, entrepreneurship and marketing. He manages both the actuarial and the benefits administration services for Zalamea.

Raymund has also been successful in launching an online employee portal that provides seamless processing of payroll, timekeeping, retirement savings and loans.

17 thoughts on “Tax Advantages of a Retirement Plan

  1. are contributions to tax-qualified plan 100% tax deductible for the company or is still subject to limit equivalent to current service cost with the excess to be amortized over 10 years?

    hope you can give me also the reference BIR Regulation please.

    Thanks.

  2. Good morning, can you give the BIR ruling that states, “for a retirement plan to be tax-qualified it must be held in trust.” This will be very useful to us in putting up our own retirement program.

    1. Hi Jeffrey,

      It’s actually not ruling but it’s in the revenue regulation RR 1-68 – Sec. 2 (i). Aside form that, there’s also Tax Code of 1997 Sec. 34 (J). If you need a copy please email info@zalamea.ph.

      [2:40]
      also Tax Code of 1997 Sec 60 (B)

  3. I am about to be 60 this coming jan. 3, 2017 but still finish the school year until april, 2017. Will i still be paying tax after my bday even if i will be working until april, 2017

  4. Good day. My wife retired from a private university after 20 years of service. According to the company, an employee, a faculty member in her case, should retire upon reaching the age of 60 or after 20 years of service, whichever comes first. As much as she would like to retire by age of 60 to have her retirement pay tax exempt, she did not have other choice but to retire after 20 years of service. However, by the time of her retirement she was only 46. Is it correct that her retirement pay was taxed?

    1. Yes, that’s correct. Because your wife was less than 50 years old at time of retirement, her benefit was taxable. Under Republic Act 4917, a retirement benefit can be tax exempt if (1) the proceeds come from a registered retirement plan, (2) the retiring employee is at least 50 years old (3) with at least 10 years of service.

      If the university had a late retirement provision, where someone can work beyond normal retirement with the consent of the company, then she could have requested for an extension until she reaches 50 years old.

  5. retirement benefits in our company have been always deducted with income tax..no one ever complained…the accounting says it’s income and therefore subject to tax..the employees do not know what the law says anyway.. who should tell us? DOLE or BIR?

    1. you would want to confirm this with your external auditor as there might be an tax exposure since you are claiming tax deductibility without a BIR registered retirement plan.

    2. you would want to confirm this with your external auditor as there might be an tax exposure since you are claiming tax deductibility without a BIR registered retirement plan.

  6. An employee, qualified for the early retirement age of 50 and more than 10 years of service in a private company, was confident that he will be tax-free. However, the company has not filed a retirement plan in the BIR. Probably, in order for the retirement plan to be approved by BIR, it has to have a retirement fund. Does the employee have to pay the tax or what is the liability of the company regarding taxes?

    1. It might not be too late for the company to set up the plan and register with the BIR. The process of setting up the plan and registering the plan with the BIR can be done in 3 months or less. If this is possible, then the benefit can still be paid out tax exempt.

      In case the company opts not to set up a retirement plan but agrees to pay out the employee, then the benefit will be taxable. Therefore, it’s the employee who shoulders for the tax.

  7. An employee more than 60 yrs old and less than 5 yrs with the company planned to retire, will he get non taxable retirement benefit from the retirement plan?

    1. under the law, the employee is not yet eligible to receive a retirement benefit. assuming the company decides to give him a benefit, the benefit will be taxable.

  8. Hi,
    upon setting up of the retirement fund, are contributions of the employer to the fund a deductible expense even though approval of the BIR on the certificate of qualification is still pending?

    1. Hi! You may also consult your auditors/tax advisors regarding this matter.There are cases however that the auditors already agree to claim as tax deductibility even if tax approval letter is still pending.

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