What is Gratuity – Meaning, Gratuity Calculation, Eligibility & Gratuity Formula

When you work for an organization with dedication, for a long time, you expect your organization to pay you back in one way or the other. Gratuity is one such way in which organizations repay the efforts and dedication of their employees who have stayed with the organization for as long as at least 5 years.

Gratuity is paid by an employer to its employees under the Payment of Gratuity Act 1972. This act binds all employers to pay a sum of money to any employee who has rendered his/her services for equal to or more than 5 years. Gratuity is paid to an employee as part of his/her salary and is considered to be a benefit plan which is designed to help the employee during his/her retirement.

What is Gratuity?

The gratuity meaning can be explained by the amount paid by an employer to its employees for rendering their services for 5 or more years. Gratuity is paid to an employee as part of his/her salary and is considered to be a benefit plan which is designed to help the employee during his/her retirement.

Gratuity Eligibility Criteria – To Whom is Gratuity Paid

Employees are eligible for receiving gratuity in the following cases-

• The employee should be retired from his/her service,
• The employee should be eligible for superannuation,
• The employee should have resigned after completing 5 years of service with any one organization,
• If the employee passes away or suffers disability due to illness or accident.

How is Gratuity Calculated – Gratuity Calculation

While you can simply use the gratuity calculator to find out the amount of gratuity that you would receive after completing 5 years of service with an organization or upon your retirement, you can also use a gratuity calculation formula to do the same. Since the payment of gratuity is covered under the Payment of Gratuity Act 1972, the rules and calculations of gratuity are prescribed by the act itself. As per the act, there are two main categories under which gratuity is paid-

• For employees who are covered under the act,
• For employees who are not covered under the act.

Gratuity for employees of both these categories is calculated differently, as explained below:

Gratuity Calculation Formula for employees who are covered under the act

To calculate the gratuity for employees who are covered under the act, you must have the number of years of the employees’ service and the employees’ last drawn salary, and then follow this formula-

Gratuity = Last drawn salary * (15/26) * Number of years of service

Here, the number of working days is taken as 26 days and the gratuity calculation is accounted for wages of 15 days. Also, it must be noted that the last drawn salary should be calculated to account for the employee’s basic salary, dearness allowance (for government employees), and the commission that is received on sales. 

Let’s take an example to understand the calculation of gratuity for employees who are covered under the act using the above formula-

Suppose your last drawn basic salary was Rs. 80,000 with an organization for which you worked for 10 years and 4 months. Now, the amount of gratuity that you would receive in such a case would be calculated as below-

Gratuity = Last drawn salary * (15/26) * Number of years of service

Gratuity = 80,000 * (15/26) * 10 

Gratuity = Rs. 4.62 lakh

It must be noted that the additional employment tenure above 10 years is only 4 months, which is less than 5; hence, the total employment tenure is rounded off to 10 and not 11 years. If the tenure would have been 10 years and 5 months or more, then the total number of years of service would be rounded off to 11 years and not 10.

Gratuity Calculation Formula for employees who are not covered under the act

There are a few organizations that are not covered under the Payment of Gratuity Act. However, the employees of these organizations are also eligible to receive gratuity under their eligible conditions. In such cases, the gratuity is calculated slightly differently. While the gratuity calculation formula remains the same, the number of total working days is taken to be 30 instead of 26. So, the formula in such a case becomes-

Gratuity = Last drawn salary * (15/30) * Number of years of service

Let’s take an example to understand the calculation of gratuity for employees who are not covered under the act using the above formula-

Suppose your last drawn basic salary was Rs. 80,000 with an organization for which you worked for 10 years and 4 months. Now, the amount of gratuity that you would receive in such a case would be calculated as below-

Gratuity = Last drawn salary * (15/30) * Number of years of service

Gratuity = 80,000 * (15/30) * 10 

Gratuity = Rs. 4 lakh

Calculation of Gratuity in case of Death of an Employee

Employees are eligible to receive gratuity in case of death or disability due to any illness or accident. In such unforeseen circumstances, a gratuity of the employee is calculated on the basis of the employment tenure of the employee. However, it must be noted that the maximum amount of gratuity that such an employee can receive is Rs. 20 lakh.

Listed below are the rates of gratuity which are payable by the employer in case of the death of an employee-

Things to Note while Calculating Gratuity!

While calculating your gratuity amount, you must note the following points-

• According to the Payments of Gratuity Act 1972, if an employee has been asked to leave his/her job due to any misconduct, the employer has the right to reject the payment of gratuity to such an employee
• In case of the death of an employee, the amount of employee’s gratuity will be given to the nominee or heir of the employee
• The current tax-free gratuity limit has been increased to Rs. 30 lakh

Gratuity Rules

The gratuity rules are created under the Payments of Gratuity Act 1972. 

• Any company which has 10 or more employees is liable to pay gratuity to its employees. This is applicable even when the number of employees in the company goes below 10
• To be eligible to receive gratuity, every employee must have completed at least 5 years of service with the company
• The calculation of gratuity is covered as per the formula laid down by the Payments of Gratuity Act, which is – Gratuity = Last drawn salary * (15/26) * Number of years of service
• An employee can ask for gratuity even before retirement; however only after completing at least 5 years of service with a company
• In case of the unfortunate demise of the employee, the gratuity must be paid to his/her nominee or legal heir and will be exempt from taxation
• If the employee faces disablement due to an accident or a disease, he/she will be entitled to his/her gratuity
• In case of discontinuation of a job due to misconduct, fraud, theft or assault, the employee cannot ask for gratuity from the company
• Even in case of bankruptcy, an employer does not have the right to deny the payment of gratuity

Wrapping it Up!

According to the Payments of Gratuity Act 1972, Gratuity is an amount paid by an employer to its employees for rendering their services for equal to or more than 5 years. Gratuity is paid to an employee as part of his/her salary and is considered to be a benefit plan which is designed to help the employee during his/her retirement. Employees are entitled to receiving the gratuity amount under situations where he/she is getting retired from his/her service, are eligible for superannuation, have resigned after completing 5 years of service with any one organization, or have passed away or suffer disability due to illness or accident.