Received VRS? How to generate passive income

People who are close to retirement and don't intend to go back to full-time work should deploy a part of their VRS money in equities so that it keeps growing at a faster rate, suggest Bindisha Sarang and Sanjay Kumar Singh.

As the impact of the economic slowdown hits home, it is fast turning into a season of pink slips.

Information technology majors like Cognizant, Infosys and Capgemini have announced retrenchment plans.

The automobile sector has witnessed mass layoffs.

Media reports suggest that over 80,000 employees of Bharat Sanchar Nigam Ltd and Mahanagar Telephone Nigam Ltd have opted for the voluntary retirement scheme offered by the public sector duo.

If you are among those who have been laid off, or intend to avail of your company's VRS scheme, here is what you need to know about the compensation you will receive, and how you should deploy the considerable corpus.

Compensation depends on period of employment

When an employer retrenches employees, it needs to pay them compensation if they fall under the purview of the Industrial Disputes (ID) Act, 1947.

Says Anuj Shah, Mumbai-based certified financial planner: "Under the ID Act, an employee is eligible for retrenchment compensation amounting to 15 days (last-drawn) salary for each year of service completed."

Employees who have worked for more than a year must be given a month's notice, or salary in lieu.

The law does not prescribe any limits on how much should be paid in a VRS.

Companies usually compute the compensation based on the number of years for which the employee has worked, and the years left until retirement.

Who qualifies

A person doing skilled, technical, unskilled, or manual job qualifies as a "workman" under the ID Act, 1947.

The nature of work is typically routine and repetitive. "Those in administrative and managerial tasks do not qualify," says Nand Kishore, advocate, DSK Legal.

Persons in jobs that require creativity or innovation also do not qualify as workmen and hence fall outside the ambit of the ID Act.

The IT-ITES industry is a case in point.

Some think that highly-qualified software professionals, for instance, should not qualify as workmen while BPO employees, who undertake mostly routine jobs, should.

There is, however, some ambiguity around this position.

A labour court in Chennai recently took the view that IT company employees are covered under the definition of workmen, and their employers should not have retrenched them without following the procedure under the ID Act.

Due to the uncertainty in the law, experts say it is prudent to take the conservative view that so long as the job undertaken is skilled, unskilled, manual, or technical, such employees would be workmen and hence entitled to benefits under the ID Act.

Tax implications

There's some good news on this count.

Section 10(10B) of the Income Tax Act provides that retrenchment compensation received by a workman under the ID Act, 1947, or any other Act, is exempt to the extent of the least of the following: actual amount received; 15 days average salary for every completed year of continuous service, or part thereof in excess of six months; or Rs 5 lakh.

Hence, if a worker gets Rs 10 lakh, he will be exempt from tax up to Rs 5 lakh and will have to pay it only on the balance.

The compensation that people in managerial or supervisory positions get is taxable as salary under Section 17(3) of the Act.

Under Section 10 (10C) of the I-T Act, 1961, VRS compensation of up to Rs 5 lakh is also tax-exempt.

The good part is that if you end up getting a compensation amount that pushes you into a higher tax slab, you don't need to worry about the extra tax.

Says Mumbai-based chartered accountant N A Shah: "If an employee has been in employment for at least three years prior to termination and his balance period of employment on the date of termination is also three years, he can claim relief under Section 89(1) read with rules 21A in respect of increased effective tax rate on account of inclusion of retrenchment compensation in his total income."

Section 89 (1) provides relief to employees on taxation of arrears.

To claim relief under this section, an employee needs to fill Form 10E and file it at www.incometaxindiaefiling.gov.in

Making the money last

A part of the money received must go into creating an emergency corpus equal to at least 12 months' household expenses, including EMIs, insurance premiums and school fees, as it is hard to tell how long the job search will take during a slowdown.

According to M Barve, a Mumbai-based financial advisor, "Younger people with many working years left may use a part of the compensation to re-skill themselves.

Some part may also be used to repay high-cost debt."

If money is still left, invest it in equity funds to meet long-term goals.

Instead of making a lump-sum investment, use the systematic transfer plan (STP) route.

People who are close to retirement and do not intend to go back to full-time work again should deploy a part of their VRS money in equities so that it keeps growing at a faster rate and helps them combat inflation (see: Invest in equity funds for at least seven years).

The balance should be invested in a variety of debt instruments to generate a regular income for meeting monthly expenses.

Of the debt portion, a part should go into buying annuities for a regular income in retirement.

"Buy an annuity plan without the return of purchase price option for better returns. And the later you buy it, the better will be the returns," says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor.

The balance of the debt portion may be invested in schemes like Senior Citizens Savings Scheme, Prime Minister Vaya Vandana Yojana, and so on.

Given the 25 years or more that people are likely to spend in retirement, they should also attempt to generate some income through part-time work to supplement the income from their investments.

• MONEY TIPS