What is Gratuity? A Comprehensive Guide for Employees

2025-05-05

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What is Gratuity? A Must-Have Guide for Every Employee

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What is Gratuity?

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Who is Eligible to Receive Gratuity?

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What is Gratuity in the Salary Calculation Formula?

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How is the Gratuity Amount Taxed?

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What are the Benefits of Gratuity?

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Conclusion

Gratuity is a crucial aspect of employee benefits that often goes unnoticed until the time of departure from a job. Understanding gratuity is essential for every employee, as it serves as a financial cushion during retirement and reflects the employer's commitment to acknowledging long-term dedication.

In this guide, we will delve into questions like what is gratuity, who is eligible to receive this benefit, how it is taxed, what the gratuity amount calculation formula is, and more for a comprehensive understanding. Let's get started!

What is Gratuity?

Gratuity is a statutory benefit governed by the Payment of Gratuity Act 1972, in India. It is a lump sum amount paid by an organisation to an employee as a gesture of gratitude for the services rendered during employment. This benefit is typically provided at the time of retirement, death, or disablement of an employee. The gratuity amount primarily depends on the last drawn salary and the duration of employment.

Who is Eligible to Receive Gratuity?

Not every employee is entitled to receive gratuity. To be eligible, an employee must meet certain criteria, which include:

Continuous Service: Gratuity is generally applicable to employees who have completed at least five years of continuous service with an organisation. However, based on recent legal interpretations, employees who have completed 4 years and 240 days of service may also be eligible. This requirement is waived in the case of death or disablement.
Termination due to Superannuation, Retirement, or Resignation: Under Section 4 of ‘Payment of Gratuity Act, 1972’, gratuity is payable only if the employment is terminated due to superannuation, retirement, or resignation post 5 years. In the case of death or disablement, the employee or their nominee is eligible to receive gratuity.

How to Calculate the Gratuity in the Salary?

The calculation of gratuity involves a specific formula outlined in the Payment of Gratuity Act. The formula is as follows:

Gratuity = [Last Drawn Salary * 15/26] * Completed Years of Service

Here, the last drawn salary refers to the monthly sum of the basic salary and dearness allowance. Commission on sales, if it is a fixed component and forms part of the monthly earnings, may also be included. Other allowances, such as HRA or bonus, are not considered in the gratuity calculation.

For example, if an employee's basic salary is ₹40,000 and the dearness allowance is ₹5,000, and they have completed 15 years of service, the gratuity amount is calculated as:

[(40,000+5,000) * 15/26] * 15= ₹3,89,423

A few points that must be kept in mind while doing this calculation are:

The maximum tax-exempt gratuity amount under the Income Tax Act is ₹20 lakhs. While employers can pay a higher amount, any gratuity received beyond this limit is taxable as per the employee’s applicable income tax slab.
The fraction of a year will be rounded off to the nearest whole number. For instance, if the service tenure is 10 years and 7 months, it will be rounded to 11 years. On the other hand, if the fraction is less than 6 months, say, 10 years 4 months, the employee will receive a gratuity for 10 years.
In cases where an employer is not covered under the Payment of Gratuity Act, gratuity may still be paid at the employer’s discretion as a gesture of goodwill. However, the calculation follows a different method based on 30 days instead of the standard 26 days.The gratuity amount in such a case is calculated using the below formula:

Gratuity = [Last Drawn Salary * 15/30] * Number of Completed Years of Service

How is the Gratuity Amount Taxed?

Gratuity enjoys tax benefits up to a certain limit under the Income Tax Act. Any amount received beyond this exempt limit is taxable as per the employee’s applicable income tax slab. Employees should be aware of these tax implications to plan their finances effectively. The tax treatment varies based on whether the employee works in the government or the private sector in the following manner:

Government Employee: For employees working in central government/state government/local authority, the entire gratuity amount is exempt from tax.
Covered Private Employee: For all other eligible employees, the least of the following amount is exempt:
- ₹20 lakhs
- The actual amount of gratuity received
- [Last Drawn Salary * 15/26] * Completed Years of Service

Any amount exceeding this limit is taxable per the employee's income tax slab

3. Not Covered Employee: If an employee is outside the ambit of the Gratuity Act, the least of the following amounts will be exempt:

₹20 lakhs
The actual amount of gratuity received
(Average salary for the last 10 months * 15/30) * Completed Years of Service

What are the Benefits of Gratuity?

Gratuity payment contributes to the overall well-being and satisfaction of the workforce. It leads to a host of benefits for both employers and employees.

Benefits for Employees:

Financial Security in Retirement: The gratuity payout assists employees in making a smoother transition to post-retirement life, covering initial expenses and ensuring a comfortable start to the retirement phase. It complements other retirement benefits and savings for a more comprehensive financial strategy.
Recognition of Long-Term Service: It serves as a tangible acknowledgement of an employee's commitment and loyalty to the organisation over an extended period. When employees see that their hard work is valued and rewarded, they feel happier and more satisfied.
Family Support in Case of Untimely Demise: In the unfortunate event of an employee's death during the course of employment, gratuity ensures that the family receives financial support, helping them cope with the sudden loss.
Tax Benefits for Covered Employees: Employees can also get a tax exemption on the gratuity they receive. This reduces their tax burden and allows them to use the amount to meet their post-retirement expenditure.

Benefits for Employers:

Compliance with Legal Obligations: Employers providing gratuity adhere to legal requirements outlined in the Payment of Gratuity Act, promoting a culture of compliance and responsible employment practices.
Increases Motivation in Employees: When employees know they'll get a little extra cash at the end of their time with a company, it can make them feel appreciated and valued. This feeling of appreciation can boost their motivation to work harder and do their best.
Enhanced Employer-Employee Relations: The transparent and timely disbursement of gratuity enhances trust and good will between employers and employees. This creates a positive work environment and harmonious employer-employee relations.
Attraction of Experienced Talent: Organisations offering gratuity can attract experienced professionals, demonstrating a commitment to recognising and rewarding long-term service. Moreover, the promise of a gratuity benefit can motivate employees to stay with an organisation for the long term. This, in turn, enhances both retention and loyalty among the workforce.

Secure Financial Well-being during Retirement

Employees should be well-informed about the eligibility criteria, calculation, taxation, and other gratuity-related aspects. Likewise, employers must adhere to the statutory requirements to ensure a smooth and transparent process of gratuity disbursement. By understanding the gratuity provisions, employees and employers can contribute to a work environment that values and rewards long-term commitment.

Employees should, however, not limit their retirement planning to gratuity alone. Old age is an uncertain period, and expenses can rise at any time. Therefore, exploring Canara HSBC Life Insurance's retirement and pension plans can be your safeguard against inflation and soaring living costs.

We offer a diverse range of retirement plans, including the ULIP Plan, Smart Guaranteed Pension Plan, and more. These plans allow individuals to make premium contributions over a period of time to build a corpus. They can then receive regular income from this corpus during their golden years. Canara HSBC Life Insurance retirement plans are thus a prudent choice for a financially stable post-retirement life.

FAQs

Employees may face challenges in receiving gratuity, such as delayed payments or disputes regarding the calculation. In such cases, employees can file grievances with the controlling authority under the Payment of Gratuity Act. Employers must address these concerns promptly to maintain a healthy employer-employee relationship and comply with legal obligations.

Nomination implies designating a family member who will receive the gratuity amount in case of the employee's demise. This facilitates a smooth and quick settlement of benefits without legal complications.

No, gratuity is solely an employer-funded benefit. Employees do not contribute to their gratuity fund. It is the employer's responsibility to make the gratuity payment.

The Payment of Gratuity Act applies to organisations with ten or more employees. Only the employers falling under the purview of this Act are mandated to provide gratuity to eligible employees.

Yes, employers have the discretion to provide a higher gratuity amount than the statutory requirement outlined in the Payment of Gratuity Act.

Disclaimer - This article is issued in the general public interest and meant for general information purposes only. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.

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