What is Gratuity?
Gratuity is a lump-sum financial payment given by an employer to an employee as a token of appreciation for their long-term service. It is a defined benefit that forms a key part of an employee’s compensation and is typically paid at the time of retirement, resignation, or in other specific circumstances.
In many countries, such as India (under the Payment of Gratuity Act, 1972), it is a mandatory statutory benefit that organizations must provide to employees who meet specific criteria.
Key Features of Gratuity
- Purpose: To reward an employee’s loyalty and long tenure.
- Nature: It is a defined benefit, meaning the formula to calculate it is fixed.
- Payment: Typically paid as a lump sum at the end of employment.
- Tax: Gratuity is often tax-exempt up to a certain limit, depending on local tax laws.
Who is Eligible for Gratuity?
While the exact rules can vary by country, eligibility is generally based on the following:
- Continuous Service: The employee must have completed a minimum number of years of continuous service with the same employer.
- Common Threshold: A common requirement is five years of continuous service.
- Termination of Employment: The payment becomes due upon the termination of employment due to:
- Retirement or superannuation.
- Resignation (after completing the minimum service period).
- Death or disablement due to an accident or disease (the 5-year minimum may be waived in this case).
How to Calculate Gratuity?
Gratuity calculation is based on a specific formula that uses the employee’s last drawn salary and their years of service.
The most widely used formula is:
Gratuity = (Last Drawn Salary) x (15/26) x (Number of Years of Service)
Breakdown of the Formula:
- Last Drawn Salary: This typically includes the Basic Salary and Dearness Allowance (DA). It usually excludes bonuses, HRA, and other variable allowances.
- 15/26: This fraction represents 15 days’ wages (half a month) based on a 26-day working month.
- Number of Years of Service:
- This is the total number of years the employee has worked for the company.
- Any period of six months or more is rounded up to the next full year. For example, 7 years and 8 months would be counted as 8 years.
- Any period less than six months is ignored. For example, 7 years and 4 months would be counted as 7 years.
Example: If an employee’s last drawn basic salary + DA was $52,000 per month and they served for 10 years and 7 months:
- Last Salary: $52,000
- Years of Service: 11 years (rounded up from 10 years, 7 months)
- Calculation: ($52,000) x (15/26) x 11 = $330,000
- Gratuity Amount: $330,000
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