What-is-Gratuity
What-is-Gratuity

What is Gratuity: Meaning, Formula for Calculation & Eligibility

A gratuity is a valuable perk that many workers enjoy. It makes sure that the company has money when an employee retires or leaves. It's not just a way to say thank you; it's also an important part of planning for retirement. Gratuity helps workers get through tough times, especially after they retire.

It's important for employees to understand gratuity. It changes their long-term plans for money and helps them get ready for life after work. Employees can make better career choices if they understand how gratuity works, how it is calculated, and who is eligible for it. It also helps them make plans for a safe retirement. Gratuity isn't just a perk; it's a way for workers to make sure they have money when they need it most.

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What is Gratuity?

A gratuity is a one-time payment that an employer makes to a worker. To show appreciation for the worker's long service, this is done. The Indian Payment of Gratuity Act, 1972 controls this benefit. Factory, mine, oil field, and plantation sites are all covered by this law, whether they are public or private. If an employee has worked for the same company for at least five years and then retires, quits, or dies, they are entitled to a gratuity.

The gratuity is like a retirement benefit. It gives the company extra money in case an employee ceases to work. Provident funds and pensions are paid for by the employee, but gratuity is paid for entirely by the employer. Because of this, it is a big part of an employee's financial security after they leave the company.

How is Gratuity Calculated?

Calculating gratuity depends on service and salary, as for any organization, in either the government sector or private sector. Formulas would vary since the gratuity eligibility criteria depends upon the type of industry, whether private sector or government.

The formula for Gratuity Calculation (Private Sector):

  • Gratuity = (Last drawn salary × years of service × 15) / 26

Example:
If an employee's last drawn salary is ₹50,000 and they have completed 10 years of service, the gratuity amount would be: 

  • Gratuity= (50,000×10×15)/26 = ₹2,88,461.

Gratuity Payable in Government Jobs

In government jobs, gratuity is normally calculated on different scales. There are also rules regarding the amount payable and the number of years that have been served. Half a month's salary is usually considered for each completed year of service, and the formula differs from one department to another and from one grade to another.

Eligibility for Gratuity

The eligibility criteria for gratuity consist of the following:

  1. Minimum Service Requirement: The employee should have rendered a continuous service for not less than five years in the same establishment; however, such requirement may be exempted in the case of the death or physical incapacitation of the employee.

  2. Employment Type: The Act covers both organized and unorganized sector employees, but for that, they must have rendered service in an institution covered under the Payment of Gratuity Act.

  3. Reason for Leaving: Gratuity is payable when the employee leaves the organization either because of retirement, resignation, or termination on completion of minimum service period.

Tax Effect on Gratuity

In India, gratuity, which is received by the employee is liable for specific tax effects as mentioned hereunder:

  • In case of central government and state government, the amount of gratuity received by an employee, either on retirement or, in the event of the death of the employee during service is exempt from taxes.

For government employees, gratuity is exempt up to the lower of the following:

  • 15 days' salary based on the last drawn salary for each completed year of service.

  • Actual amount of gratuity received.

  • ₹20 lakh (as per current rules).

Employees must seek the financial advice so that the employees can understand how gratuity fits into their overall tax plan and how the retirement funds are optimized well.

Factors Affecting Gratuity

There are various factors that affect the gratuity amount given to an employee. First, the more the time served, the more one gets as gratuity as it is directly proportional with the years of service and the gratuity is taken on the basis of an employee's last drawn salary which includes basic pay, and dearness allowance, among others.

  • Industry Regulations: Gratuities differ in every industry because they are set in place with the employees and the law that a firm adopts.

  • Company Policy: Some firms allow gratuities above the statutory minimum. It boosts the payment that goes to the employee, and it is one of the ways of keeping the employees.

Also, Find out What are the provisions of Wages Act 1936

Benefits of Gratuity

Gratuity offers a number of benefits to employees, especially at the age of retirement:

  • Financial Security: It gives a significant amount of money as a post-retirement backup, hence keeping the lifestyle afloat and some other un-expected expenditures.

  • Recognition for Service: A gratuity is a form of compensation for loyalty, rewarding the employee for his or her loyalty and long-term association with the company.

  • Retirement Planning: Gratuity is an essential component of an employee's retirement fund, complementing other savings or pensions.

  • Tax Relief: Eligible employees can claim tax exemptions on gratuity, thereby reducing the tax burden on their retirement benefits.

Summary

If an employee has worked for a company for a long time, they may give them a gratuity as a reward. Payment of Gratuity Act, 1972 sets the rules for it, and it affects workers in both the public and private sectors. Workers must have worked for the company for at least five years in order to be eligible. The last salary and number of years of service are used to figure out the gratuity. It's not taxed for people who work for the government and has some exceptions for people who work for private companies. A gratuity helps an employee plan for their financial future after they retire or quit.

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What is Gratuity: FAQs

Q1: What is gratuity, and how does it benefit employees?

Gratuity is the benefit under the Employees' Provident Fund that is granted to the employees in a certain amount for a specific amount of service with their respective employers. The sum obtained from this facility offers long-term financial security and forms a source of encouragement from the employer side in view of an employee's consistent loyalty towards him.

Q2: What are the gratuity eligibility criteria in India?

All Indian employees are entitled to the gratuity benefits except employees who have lost their lives or are rendered completely unfit for work during service with a particular employer.

Q3: What does gratuity eligibility in India calculate?

Gratuity is computed based on the last drawn salary, years of service, and specific formulas which differ according to the sector. For private sector employees, it is usually computed by using

(Last drawn salary×years of service×15)/26.

Q4: Is gratuity taxable?

For the government employee, gratuity is fully exempt from tax. For private employees, it is exempt up to ₹20 lakh depending on certain conditions.

Q5: What happens if an employee dies before completing five years of service?

In such circumstances, gratuity is granted to the nominee or employee's family. Service duration is not applicable in this scenario.

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