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Gratuity

General

Gratuity

A lump-sum payment made by an employer to an employee as a token of gratitude for long service, payable on resignation, retirement, or death after completing 5 years of continuous service.

Definition

Gratuity is a lump-sum payment made by an employer to an employee as an expression of gratitude for long-term service. Under the Payment of Gratuity Act, 1972, it is a statutory entitlement for employees who have completed at least 5 years of continuous service with the same employer, payable on resignation, retirement, death, or disablement due to accident or disease.

Gratuity is calculated based on the last drawn basic salary (plus DA) and the number of years of completed service. It is one of the three major retirement/terminal benefits in India's organised sector — alongside EPF (monthly provident fund accumulation) and leave encashment.

From the employer's perspective, gratuity is a deferred salary obligation that grows with each year of employee tenure — many companies create a gratuity fund (often managed by LIC or insurance companies) to provision this liability annually.

Formula

For employees covered under the Gratuity Act:

Gratuity = (Last Drawn Basic Salary + DA) × 15/26 × Years of Completed Service

The factor 15/26 represents 15 days' wage for each year, where a month is considered to have 26 working days.

For employees NOT covered under the Gratuity Act:

Gratuity = (Last Drawn Basic Salary + DA) × 15/30 × Years of Completed Service

(Half a month's salary per year of service)

Worked Example

Ravi resigns after 12 years and 8 months of service. His last drawn basic salary + DA = ₹60,000/month.

Years of completed service = 13 (8 months > 6 months rounds up to the next year)

Gratuity = ₹60,000 × 15/26 × 13 = ₹60,000 × 0.577 × 13 = ₹4,50,000

Tax calculation:

  • Tax exemption limit (Gratuity Act employee): ₹20 lakh
  • Actual gratuity: ₹4.5 lakh < ₹20 lakh
  • Gratuity is fully tax-exempt

If Ravi had served 30 years with basic salary of ₹1,20,000:

  • Gratuity = ₹1,20,000 × 15/26 × 30 = ₹20,76,923
  • ₹76,923 above ₹20 lakh is taxable as salary income

Use the gratuity calculator for your specific scenario.

Key Things to Know

  • Gratuity is a CTC component: Many employers include an annual gratuity provision (4.81% of basic salary = 15/26 of one month's salary) in the CTC. This appears as a deferred benefit — you don't receive it until leaving after 5 years. New employees often overestimate take-home when they see gratuity in their CTC breakdown.
  • 5-year cliff: Gratuity has a strict 5-year threshold — resign in year 4, year 11 months, and you receive zero gratuity. This creates a financial incentive to complete the fifth year before switching jobs. The partial exception (4 years + 240 days) can matter significantly for employees near the threshold.
  • Gratuity on retirement vs resignation: Many HR departments don't proactively process gratuity — the employee must claim it formally within 30 days of becoming eligible. Employers must process and pay within 30 days of receipt of the claim. Delay beyond 30 days attracts simple interest at 10% per annum on the outstanding amount.
  • Gratuity fund vs unfunded: Progressive companies set aside gratuity liability annually into an approved gratuity fund (typically managed by LIC Group Gratuity scheme or private trusts). Other companies carry it as an unfunded liability on the balance sheet. From an employee's perspective, a funded gratuity is safer — the money exists even if the company faces financial difficulty.
  • Gratuity vs EPF — key difference: EPF is portable — you carry the accumulated balance as you move from employer to employer through the UAN system. Gratuity is not portable — it's earned at each employer separately and is forfeited if you leave before 5 years. This makes gratuity a strong retention tool for employers and a consideration for employees when evaluating job changes.

Related Calculators

Gratuity Calculator →Calculate your gratuity amount using India's Payment of Gratuity Act formula. Find your exact payout and tax-exempt limit based on salary and service years.
Salary / CTC Calculator →Calculate your in-hand monthly salary from CTC in India. Breaks down basic, HRA, PF, professional tax, income tax TDS to show your net take-home pay.
Retirement Calculator →Calculate your retirement corpus and monthly income in India. Enter current age, savings, monthly investment, returns and inflation to plan your retirement.

Related Terms

EPFEmployee Provident FundCTCCost to CompanyTDSTax Deducted at Source
Frequently Asked Questions
Is gratuity mandatory for all employers?
Under the Payment of Gratuity Act 1972, gratuity is mandatory for organisations with 10 or more employees. Once covered, an organisation remains covered even if the employee count falls below 10. Private sector organisations not covered under the Act may still pay gratuity voluntarily or as per employment contract terms. The central government extended gratuity coverage to all employees regardless of organisation size in 2018 amendments.
How is the 5-year service condition calculated?
The 5-year continuous service requirement has one important exception: if an employee has completed 4 years and 240 days of service (where the year has more than 6 working days per week) or 4 years and 190 working days (in organisations with 5 or 6 working day weeks), they are considered to have completed 5 years of service for gratuity purposes. This rule was established by the Supreme Court.
What is the maximum gratuity tax exemption?
For private sector employees covered under the Payment of Gratuity Act, the tax exemption is the least of: (1) Actual gratuity received; (2) ₹20 lakh (enhanced from ₹10 lakh in 2019); (3) 15 days' salary for each completed year of service. Gratuity above ₹20 lakh is taxable as salary income. Government employees receive full tax exemption with no ceiling. Employees not covered under the Act have different calculation rules for exemption.
What happens to gratuity if the employee dies?
If an employee dies during service (before completing 5 years), the gratuity is still payable to the nominee without the 5-year condition. The same gratuity formula applies based on years of service. The employer must pay within 30 days of the death. The nominee (designated by the employee, or legal heirs if no nominee exists) receives the gratuity tax-free regardless of amount.
Is gratuity calculated on basic salary or CTC?
Gratuity is calculated on basic salary + dearness allowance (DA) only — not on total CTC or gross salary. Allowances (HRA, travel, food) are excluded. This is why high-CTC employees with low basic salary pay may receive lower gratuity than expected. Some companies structure CTC to minimise basic salary specifically to reduce gratuity liability — though this has tax implications for the employee on other components.