What is Gratuity in Salary & How to Calculate it

The gratuity amount is one of the superannuation benefits employees can derive from their employers. While it's a retirement benefit, you can also claim it before your golden years. This article will help you understand what is the meaning of gratuity, how is it calculated and when gratuity is paid out.

What is the Meaning of Gratuity in Salary?

Gratuity is a monetary token of appreciation for employees with at least five years of continuous service in a company. Employers can pay it from their own account or opt for a gratuity insurance provider, with all payments covered by the Payment of Gratuity Act 1972.

What is the Eligibility for Gratuity?

The following circumstances are eligible for gratuity payments:

• If the employee qualifies for superannuation.
• If the employee resigns from the company after continuous service of at least five years.
• If the employee retires from the organisation.
• If the employee suffers from a disability due to an accident or illness.
• If the employee passes away.

How to Calculate the Gratuity Amount?

You can use this gratuity calculator to calculate this in just a minute or less. But nonetheless, here’s the formula if you want to do the math yourself.

The gratuity amount is calculated using the following simple formula:

Gratuity = N x B x 15/26 

Where N is the number of years you’ve worked at the company, and B is your last drawn salary (including DA). Thus, gratuity is always calculated as a product of your years of service and your last credited salary amount.

Remember:

• The employer can pay more gratuity than the results of this formula, with the upper limit set at ₹20 Lakhs.
• If you’ve worked for more than six months during your last year of employment, it's rounded off to the next whole number.
• If you’ve worked for less than six months, your employment tenure is rounded off to the next lower number.

Let's find out what is the gratuity amount under three specific scenarios:

1. Calculating Gratuity for Employees Covered Under the Act

The gratuity amount formula remains unchanged for employees covered under the Payments of Gratuity Act. Let’s take an example to see how we can calculate gratuity using the standard formula.

Let’s say you’ve served at a company for ten years and are now looking for better opportunities. Your last salary was ₹60,000 (including dearness allowance). Given these figures, the gratuity due to you will be:

Gratuity = N x B x 15/26

= 10 x ₹60,000 x 15/26

= ₹3,46,154

2. Calculating Gratuity for Employees Not Covered under the Act

Employees working for organisations not covered under the Payments of Gratuity Act can also earn gratuity. However, in such cases, the gratuity amount calculation is based on the half month’s salary (basic pay, DA, commissions) for the total number of employment years. The formula used is:

Gratuity = (15 x last drawn salary x service period) / 30

Let’s say you’ve worked at the organisation for five years and ten months and your last drawn salary was ₹40,000. In this case, the gratuity amount due will be:

Gratuity = (15 x 40,000 x 6) / 30

= (36,00,000) /30

= ₹1,20,000

(Note: As per the rounding norms discussed above, service years have been rounded off to 6 years) 

3. Calculating Gratuity for Deceased Employees

If the employee in question passes away, the gratuity amount is calculated on the number of service years. The upper cap of ₹20 Lakhs is still applicable in such cases, and the gratuity amount will accrue to your nominee or dependent.

The following table clearly states the gratuity amount due in such cases.

Half the basic salary for every 6 months of employment but not more than 33 times the basic salary.

What is the Taxation like on Gratuity?

Gratuity amounts payable to central, state and local government employees is completely free from income tax deductions.

Gratuity amount payable to private employees working for organisations covered under the Gratuity Act, exemptions apply on the least of these three values:

• Gratuity less than ₹20 Lakhs.
• Actual value of gratuity received.
• Fifteen days’ salary (calculated on the last drawn salary) for each completed year of employment.

Gratuity amount payable to private employees working for organisations not covered under the Act, exemptions apply for the least of these three values:

• A gratuity of less than ₹10 Lakhs.
• Actual gratuity received.
• Half-month’s salary (based on the last ten months' average salary) for each completed year of employment.

What is Gratuity Forfeiture?

As per the Gratuity Payment Act, your employer can forfeit a part or the full gratuity amount. However, such forfeitures are only applicable when your employment is terminated for disorderly conduct that injures a fellow employee.

How & When Gratuity is Paid Out?

To claim your gratuity amount, you have to fill out an application form and submit it to your employer. Once that’s done, your employer will assess it and compute your gratuity amount. The company will notify the gratuity paying authority, and the amount will be disbursed in 30 days. You will also receive an acknowledgement for when gratuity is paid out to you.

Summing It Up

Gratuity is essentially a retirement benefit awarded to the employee for years of service to a company. However, the gratuity amount can also be claimed while exiting the company after five years of service or if the employee dies or is disabled. As such, the calculation procedure and taxation norms on gratuity differ depending on the organisation.

Frequently Asked Questions

1. Is there a maximum amount of gratuity I can receive?

Yes. As per the latest amendment to the Gratuity Payment Act, the gratuity cap for private sector employees covered by the Act now stands at ₹20 Lakhs. Earlier, the maximum gratuity payable to an employee was ₹10 Lakhs.

2. When is the Gratuity amount payable to an individual?

The gratuity amount is payable to employees if they have completed five years of continuous service at the company. Retiring employees are also eligible for the gratuity amount as part of their superannuation benefits. These general gratuity payment norms are overstepped when employees pass away or are disabled due to injury or illness.

3. Is gratuity paid with salary?

If and when eligible, Gratuity is paid to an employee either as a part of the last salary payment or as a part of the full and final settlement.

4. Does gratuity cut from salary?

Yes, employers deduct gratuity from an employee's salary and allowances. Employees' salary structure is often considered when calculating gratuity.

5. Is PF and gratuity same?

In a PF account, contributions are made by both the employer and the employee. However, in contrast, gratuity does not involve any contribution from the employee. Instead, it is a symbolic monetary amount provided to an employee as a gesture of appreciation for their dedication and loyalty. 
 

6. Is gratuity compulsory?

The Payment of Gratuity Act, 1972 is legislation that mandates employers to make gratuity payments to their employees. This Act covers employees in various sectors such as mines, oilfields, railways, factories, ports, shops, and establishments, ensuring they are entitled to the benefits provided by the Act.

7. Can employees withdraw gratuity?

As and when eligible, an employee can apply to withdraw gratuity by filling in the gratuity claims form ordinarily within thirty days from the date the gratuity became payable.

8. Who is eligible for gratuity?

Here is the eligibility criteria for gratuity: 
 

• If the employee qualifies for superannuation.
• If the employee resigns from the company after continuous service of at least five years.
• If the employee retires from the organisation.
• If the employee suffers from a disability due to an accident or illness.
• If the employee passes away.

9. What is the gratuity calculation formula?

Calculating gratuity is easy and straightforward with few complications.

Gratuity formula: 

Where, N = number of years completed in the company, and B = last withdrawn basic salary (dearness allowance in addition).