When you retire from a job, along with the Provident Fund and Pension Fund, you also receive a sum of money known as Gratuity. In today’s world, staying with one company for an entire career is rare, as people tend to change jobs frequently. However, even those who have spent at least five years with a single company are eligible for gratuity. Let’s address some common questions that many employees have: What is gratuity? How is it calculated? When do I become eligible for gratuity? How much of the gratuity amount is tax-free, and how much is taxable?
Many people look forward to receiving gratuity upon retirement (or when changing jobs) to fulfill their unfulfilled dreams or manage routine expenses. However, as we mentioned earlier, gratuity is something that many employees don’t fully understand and often ask colleagues, the accounts department, or even a chartered accountant for help. So today, we are here to answer all your questions about gratuity.
What is Gratuity?
Gratuity is a benefit that your employer gives you as a farewell gift in return for your years of service. It is a part of the retirement benefits that employees receive when they leave or retire from their job.
When Do You Get Gratuity?
Gratuity is given to any employee who has worked for at least 4 years, 10 months, and 11 days continuously before leaving the job or retiring. This period is generally considered as five years of continuous service. According to the rules, an employee is eligible for gratuity only after completing five years of service. So, if you frequently change jobs after a year or two, you won’t be eligible for gratuity.
How to Calculate Gratuity?
Salaries are paid monthly, and employees generally know how much basic salary, dearness allowance (DA), house rent allowance (HRA), and income tax deductions they receive. But not everyone knows how to calculate gratuity when they retire or change jobs. So, let’s explain the formula to calculate gratuity, which is quite simple. If you have worked in a company for less than five years, you won’t receive gratuity. But if you have spent more than five years, you are entitled to gratuity for the entire duration of your service. After completing five years of service, the gratuity is calculated based on the last drawn basic salary and dearness allowance (for those who don’t receive DA, only the basic salary is considered). The formula is as follows:
Gratuity = [(Last month’s basic salary + Dearness Allowance) x 15 x Number of years in service] / 26
Let’s Take an Example
Suppose you worked for a company for 21 years and 11 months. Your last drawn basic salary was ₹50,000, and you received a dearness allowance of ₹25,000. In this case, your service period will be counted as 22 years. Now, add ₹50,000 and ₹25,000, which gives you ₹75,000. Multiply this by 15, and you get ₹11,25,000. Now, multiply this amount by the total years of service, which is 22. This gives you ₹2,47,50,000. Finally, divide this amount by 26, and you will get ₹9,51,923. This is the gratuity amount you are entitled to receive.
How Much of the Gratuity is Tax-Free?
If your gratuity is calculated using the formula mentioned above and your employer has not given you any additional amount as a gift, then up to ₹20,00,000 of the gratuity amount is completely tax-free. You won’t have to pay any tax on this amount.