Budget 2026: When retirement becomes a tax trap – why India’s wage earners urgently need relief

India’s working class feels pressured – not because they don’t want to pay taxes, but because the system increasingly views retirement savings as a luxury. (AI image)

For a country that prides itself on its thriving middle class, India’s tax treatment of retirement savings seems strangely out of touch with economic reality. In recent years, a series of changes presented as “streamlinings” have quietly created a minefield for employees who believed they were doing the right thing by saving for their future.Three provisions stand out for the burden they impose: taxation of employer contributions to provident and pension funds in excess of ₹7.5 lakh; annual taxation of the gains on such excess contributions; and taxation of interest earned on the employee’s own pension contributions exceeding ₹2.5 lakh. Taken on their own, each may seem technical. Together, they redesign retirement planning so that employees have little clarity, greater financial anxiety, and a rising tax burden on income they don’t even receive today.A tax before the benefit arrivesThe first shock for employees came with the Finance Act of 2020, which limited employer contributions to recognized pension schemes, authorized pension funds and NPS at ₹7.5 lakh per annum. Anything above that – which is common among senior professionals, mid-level employees in high-cost cities, and employees in organizations with generous retirement policies – became taxable as a fringe benefit.What’s even worse is that the annual growth – interest, dividends or similar growth – is also taxed on this “excess contribution”. every single year. This is a tax on fictitious income long before the employee sees a single rupee of it.Many describe this as an upfront disadvantage when saving. In contrast to bonuses or cash payments, pension contributions are tied to the long term. Yet taxes are levied today on funds that may not be received until decades later. This disproportion between Tax incidence And actual receipt has become a major pain point.When liberation isn’t really liberationThe distress deepens when the national pension system comes into play. While the government justified taxing excessive employer contributions by claiming that pension schemes, superannuation schemes and NPS were an “EEA scheme”, the law does not fully support this claim.As per Section 10(12A), up to 60% of the NPS corpus can be withdrawn tax-free if the account is closed or NPS withdrawal is deactivated. The remaining 40% must be used to take out an annuity insurance policy with a life insurance company and the pension from this annuity is fully taxable. Employees therefore argue that the premise of a completely exempt regulation is incorrect.Taxation of an employee’s own retirement savingsThe Finance Bill, 2021 has introduced another blow: PF interest on employee’s own contribution beyond Rs 2.5 lakh per annum is taxable.For many mid-career workers, retirement planning is the only disciplined savings tool they can rely on. A high PF contribution is not a luxury; It is a way to secure the future without universal social security.Nevertheless, the law now characterizes high contributions – even if they are mandatory or part of the salary structure – as an attempt to enjoy “full exemption”. For those whose basic salary is so high that the statutory 12% pension contribution can cross even the ₹2.5 lakh threshold, the disadvantage is even greater, triggering a tax on interest even if the employee never intended to make “excess contributions”. This change will be seen as particularly harsh in a country where inflation is eroding purchasing power and where pension adequacy is already a problem.“Furthermore, these changes all appear to be part of the government’s ultimate goal of abolishing all deductions and exemptions and making the ‘new tax system’ the only system available to all taxpayers,” says Ameet Patel, partner at Manohar Chowdhry & Associates.The big picture: When rules punish good behaviorA consistent theme emerges in these provisions:India now taxes retirement savings more aggressively. Employees who save diligently, especially mid- to senior-level employees, face the following:

The result is that long-term savings face multiple tax points.Why reforms are neededThere is a growing consensus among industry associations that these provisions need to be urgently reviewed. The argument is not about giving employees a profit, but rather about ensuring fairness and a safety net. Given an aging population, the lack of a universal social security system covering all citizens and rising costs of living, existing provisions are disadvantageous. India’s working class feels pressured – not because they don’t want to pay taxes, but because the system increasingly sees retirement savings as a luxury rather than a necessity. What was once a predictable, trustworthy path to savings is now riddled with caps, tax triggers and compliance complications.“And this exacerbates the problems faced by the aging population when insurance companies either refuse to issue new health insurance policies to senior citizens or charge such high premiums on the policies that purchasing mediclaim insurance for such pensioners becomes extremely expensive. When such a person has to pay large amounts to hospitals for medical treatment, the depleted savings are often not enough and the entire family is under a lot of financial pressure,” concludes Patel.