Gratuity forms an integral element of the employee benefits package, thereby providing financial security at the time of retirement or leaving an organization. A benefit regarded as a recompense for long-term service is not merely an expression of gratitude but forms an important element of retirement planning among employees in India and in many other nations. Gratuity acts like a cushion to the pocket, assisting employees during such transitional periods, especially during retirement.
Understanding gratuity and its implications is significant to the employees because gratuity impacts their long-term plans financially and ensures preparation after work. Knowing the mechanisms of gratuity, the method of calculation, and the eligibility criteria are thus helpful for employees for good career decisions and also help in planning a good and stable retirement.
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What is Gratuity?
Gratuity is the amount that is paid as a one-time payment to an employee by his employer, which forms the expression of appreciation for his service rendered during a period considered substantial. Gratuity is governed by the Payment of Gratuity Act 1972 of India and is applicable in both the private and public sectors including factories, mines, oil fields, and plantations. It falls due at the time of retirement, resignation, or death subject to having completed a minimum continuous period of service with the employer of normally five years.
Gratuity forms some sort of retirement benefit to the employee; usually provided as a fall back when meeting various financial requirements at the time one leaves active employment. Provident funds and pensions are not payable by the employee, and gratuity is funded completely by employers.
Also, learn about the Gratuity Act 1972.
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 eligibility 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.
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Eligibility for Gratuity
The eligibility criteria for gratuity consist of the following:
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.
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.
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.
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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.
Read about the 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.
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.
