What is gratuity and who gets it?
Gratuity is a lump-sum amount paid by an employer to an employee as a reward for long-term service. It is governed by the Payment of Gratuity Act, 1972, and applies to establishments with 10 or more employees. For employees, it acts as a retirement or resignation benefit and can be a significant sum after many years of service. Understanding how it is calculated and when it is paid helps you plan your finances and know what to expect at the end of your tenure.
Key Takeaways
- Gratuity is payable after 5 years of continuous service (resignation, retirement, superannuation, or death).
- Formula: (Last drawn basic + DA) × (15/26) × Completed years of service.
- Last drawn salary means basic + dearness allowance; HRA and other allowances are not included.
- Maximum gratuity exempt from tax is ₹20 lakh (lifetime); government employees get full exemption.
- Use a gratuity calculator to estimate your amount based on current salary and years of service.
What Is Gratuity?
Gratuity is a statutory benefit paid by the employer when an employee leaves after completing at least five years of continuous service. It is meant to reward loyalty and long service. The Payment of Gratuity Act, 1972, defines the rules for calculation, eligibility, and payment. Employers covered under the Act must pay gratuity; many others also pay it as part of company policy. The amount is typically paid at the time of resignation, retirement, superannuation, or in case of death of the employee.
Gratuity Calculation Formula
Understanding the Formula
Last drawn salary refers to basic salary plus dearness allowance (DA) at the time of leaving. HRA, special allowance, and other components are not included. The factor 15/26 represents 15 days of salary per year of service (based on 26 working days in a month). Completed years of service mean full years; if you have worked for 10 years and 7 months, it is 10 years for the formula. If you have completed more than 6 months in the additional year, it is rounded up (e.g. 10 years 7 months = 11 years).
Worked Example
- Last drawn basic salary: ₹50,000
- Dearness allowance: ₹10,000
- Last drawn (basic + DA): ₹60,000
- Completed years of service: 12 years
- Calculation: (60,000 × 15 ÷ 26) × 12 = 34,615.38 × 12 = ₹4,15,385 (approx.)
- This is the gratuity amount payable (subject to the ₹20 lakh cap under the Act).
Eligibility: When Is Gratuity Payable?
Gratuity is payable when an employee leaves after completing at least 5 years of continuous service. This applies to resignation, retirement, superannuation, or termination (except in case of misconduct as per law). In case of death or permanent disability, gratuity is payable even if the employee has not completed 5 years. Continuous service includes normal working days and certain types of leave (e.g. leave, sickness, maternity) as defined under the Act; long unpaid breaks may affect continuity.
Tax on Gratuity
For employees covered under the Payment of Gratuity Act, the amount received as gratuity is exempt from tax up to the lowest of: (1) actual gratuity received, (2) ₹20 lakh (lifetime limit), or (3) the amount calculated as per the Act formula. Any amount above the exempt limit is taxable. For central and state government employees, gratuity is fully exempt. For employees not covered under the Act, different exemption rules and limits apply. Plan for possible tax if your gratuity is likely to exceed the exempt limit.
Factors That Affect Your Gratuity
- Last drawn basic + DA: Higher salary at exit means higher gratuity.
- Years of service: Each additional year adds (15/26) × (basic + DA) to the amount.
- Rounding: More than 6 months in an extra year is counted as a full year.
- Cap: Under the Act, maximum gratuity is ₹20 lakh (though employers can pay more; the excess may be taxable).
Is your organisation covered under the Gratuity Act?
The Payment of Gratuity Act applies to establishments such as factories, mines, oilfields, plantations, ports, railways, shops, and other organisations with 10 or more employees. If your employer is not covered, they may still pay gratuity as per company policy or your employment contract. In that case, the formula and eligibility may differ; check your offer letter and HR policy. Government employees are covered under separate rules and typically receive gratuity as per their service conditions.
When is gratuity paid: Resignation, retirement, and death
Gratuity is payable when you leave after 5 or more years of service—on resignation, retirement, superannuation, or termination (other than for misconduct as per law). In case of death of the employee, gratuity is paid to the nominee or legal heir even if the employee had not completed 5 years; the amount is based on actual service. In case of permanent disablement, gratuity is payable even before 5 years. The employer must pay gratuity within 30 days of it becoming payable; delay can attract interest and penalty as per the Act.
How to claim gratuity: Documents and process
When you leave the organisation, submit a gratuity claim form along with proof of resignation or retirement and identity proof. The employer will verify your service and salary and calculate the amount. If there is a dispute, you can approach the controlling authority under the Act. Keep copies of your last payslips, appointment letter, and service certificates so that calculation can be verified. If the employer has a group gratuity policy with an insurer, the process may involve the insurer; HR will guide you on the exact steps.
Gratuity and job change: What happens when you switch companies
Gratuity is not portable between employers. When you switch jobs, you receive gratuity from your previous employer only if you had completed 5 years there. Your new employer will start a fresh gratuity calculation from zero. So if you change jobs every 3–4 years, you may never receive gratuity from any single employer unless you stay for 5+ years. This is one reason long tenure with one employer has a financial benefit in the form of gratuity; however, job changes often bring higher salary growth, so the decision depends on your overall career and financial goals.
Maximum gratuity limit and tax on excess
Under the Payment of Gratuity Act, the maximum gratuity that can be paid is ₹20 lakh (as per the current cap). Any amount above this paid by the employer may still be received but the tax exemption is limited to ₹20 lakh. The excess is taxable as salary income in the year of receipt. Some employers have a policy of paying gratuity beyond the Act limit for senior employees; in such cases, plan for the tax on the excess and consider spreading investments or deductions in that year to reduce tax impact.
Use the Gratuity Calculator
Use the Gratuity Calculator to estimate how much gratuity you may receive based on your current basic, DA, and expected years of service. This helps you plan for retirement or job change and understand the impact of salary growth on your gratuity.