Unlocking Gratuity: A Comprehensive Guide for Employees

Written by : Knowledge Centre Team

2024-02-26

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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 go 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 is gratuity amount calculation formula, 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 of 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, or on the death or disablement of an employee. It mainly depends on your last drawn salary and the years you've worked for the company.

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 applicable only to employees who have completed at least five years of service with an organisation. This requirement is, however, waived in the case of death or disablement.
Termination due to Superannuation, Retirement, or Resignation: Under Section 4 of ‘Payment of Gratuity Act’, 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 includes basic salary, dearness allowance, and commission on sales, if any. For instance, if an employee gets a basic salary of ₹40,000 and a dearness allowance of ₹5,000 and completes 15 years of employment, the gratuity amount will be calculated as follows: [(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 gratuity amount cannot exceed ₹20 Lakhs.
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.
Even if the company isn't subject to the Gratuity Act, employees will still receive gratuity payments. However, the calculation will be 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. 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:

1. Government Employee: For employees working in central government/state government/local authority, the entire gratuity amount is exempt from tax.

2. 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

₹10 lakhs
The actual amount of gratuity received
(Average salary for the last 10 months * 15/30) * Number of 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 Employers: 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 goodwill 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 enhances employee retention and loyalty.

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, buying Canara HSBC retirement and pension plans can be your safeguard against inflation and soaring living costs.

We offer a diverse range of retirement plans, including the Invest 4G Plan, Smart Guaranteed Pension Plan, Smart Lifelong Plan, Secure Bhavishya Plan, Saral 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 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.

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