Last Updated:
Gratuity is a lump sum payment made by an employer to an employee at the time of retirement, resignation, or upon completing a specified period of service. Here’s everything you need to know:
Gratuity is a statutory benefit in India and is applicable to employees working in establishments with 10 or more employees.
Gratuity is a financial benefit that employers provide to employees as a token of appreciation for their long-term service. Governed by the Payment of Gratuity Act, 1972, gratuity serves as a form of retirement benefit, ensuring financial security for employees who have dedicated years to a company.
What is Gratuity?
Gratuity is a lump sum payment made by an employer to an employee at the time of retirement, resignation, or upon completing a specified period of service. It is a statutory benefit in India and is applicable to employees working in establishments with 10 or more employees. The employer provides gratuity as a goodwill gesture, but it is also a legal obligation under the Payment of Gratuity Act.
When Do You Become Eligible for Gratuity?
To qualify for gratuity, an employee must meet the following conditions:
1. Minimum Service Period: Employees must complete at least five continuous years with the same employer to be eligible for gratuity. However, this rule is waived in the case of death or disability.
2. Employment Type: Gratuity applies to employees in factories, mines, plantations, shops, and other establishments with 10 or more employees.
3. Resignation, Retirement, or Termination: Employees receive gratuity upon resignation, retirement, termination, or in case of death or disability.
How to Calculate Gratuity?
Gratuity is calculated based on the employee’s last drawn salary and years of service. The formula differs for employees covered under the Gratuity Act and those who are not.
Gratuity Calculation Formula (for employees under the Act)
The standard formula for gratuity is:
Gratuity = (Last Drawn Salary × 15 × Number of Years of Service) / 26
Example: Suppose an employee has worked for 10 years with a last drawn salary (basic + dearness allowance) of Rs 50,000.
(50,000 × 15 × 10) / 26 = Rs 2,88,461.54
Here, 15 represents 15 days’ wages for each completed year, and 26 is the number of working days in a month.
For Employees Not Covered Under the Act
Some organisations that do not fall under the Payment of Gratuity Act calculate gratuity differently:
Gratuity = (Last Drawn Salary × 15 × Number of Years of Service) / 30
This method results in a slightly lower payout.
Taxation on Gratuity
Gratuity taxation depends on the type of employee:
Government Employees: Fully tax-free.
Private Sector Employees Covered Under the Act: Exempt up to Rs 20 lakh in a lifetime.
Private Sector Employees Not Covered Under the Act: Tax exemption applies to the least of the following:
1. Actual gratuity received
2. Rs 20 lakh
3. Gratuity calculated using the formula
Key Points to Remember
– Gratuity is not deducted from the employee’s salary; the employer funds it.
– The five-year continuous service rule includes maternity leave and other paid leaves.
– Employees can nominate a family member for gratuity benefits.
– In case of death or disability, the gratuity is paid to the nominee without requiring five years of service.