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What is Gratuity and how you benefit from it

In this day and age of job hopping, many of us don’t know what gratuity is. This article explains gratuity in detail, who is eligible for it, how much can you get through it, etc. It also explains what the recent change in the gratuity limit – from Rs. 3.5 Lakhs to Rs. 10 Lakhs – means to you.

You might have heard about gratuity. It might also form a part of your CTC package. (Read “Cost To Company or CTC salary: Understanding and Calculation” for more on CTC).

But do you know what gratuity is? How can it help you? Whether you are eligible for it? How much do you get as gratuity, and when? Let’s find out.

What is Gratuity?

Gratuity is intended to be a retirement benefit, just like Provident Fund (PF).

(Please read “Provident Fund (PF) and Voluntary Provident Fund (VPF)” for more on PF)

However, you need not wait till retirement to get this money.

When do you get the gratuity amount?

You get the gratuity amount at the time of retirement or resignation, provided you have completed at least 5 years of service in the organization.

In case of an employee’s death, the gratuity amount is payable even if he or she has not completed 5 years of service in the organization.

Who is eligible for gratuity?

Any employer that has ten or more salaried employees / workers has to provide gratuity to the eligible employees. As mentioned above, you would be eligible to get gratuity only if you have completed a minimum of 5 years of service in the company.

Thus, you can get gratuity amount if you work in an organization employing 10 or more people, and if you have completed 5 years in your job.

How much do you get as gratuity?

In simple terms, you get half a month’s salary for each completed year in service in the organization. Thus, if you resign after serving for 6 years, you get an amount equal to 3 months salary as gratuity.

To be precise,

Gratuity amount = ( Monthly Salary / 26 ) * 15 * Number of years of service

This amount, however, was subject to a ceiling of Rs. 3,50,000. Thus, the maximum gratuity payable was Rs. 3.5 Lakhs. (This is as mandated by the law – there are some companies who are more liberal, and do not have any upper limit on the gratuity amount).

This maximum amount has been increased to Rs. 10,00,000 (Rs. 10 Lakhs) recently. (More on this later)

What is “Salary” for calculation of gratuity?

Before you feel too happy or excited, please note that the definition of “salary” for the purpose of calculating the gratuity is quite narrow.

Salary just means your basic, and dearness allowance (DA), if any. Any House Rent Allowance (HRA), special allowance, travel allowance, any other allowance or any other component of your salary can not be included in this calculation.

However, a positive is that the “salary” to be considered for gratuity calculation is your last drawn salary.

Income Tax (IT) Treatment of gratuity proceeds

Any amount that you receive as gratuity is added to your income for that year under the head “Income from Salary”. However, exemption is available upto a certain amount under section 10(10) of the Income Tax (IT) Act.

To calculate this exemption, employees are classified in three categories depending on their type of employment and their coverage under the Payment of Gratuity Act.

In short, the entire amount received as gratuity is tax-free for government employees. Whereas for non-government employees, the maximum possible exemption is Rs. 3,50,000. (This should be increased to Rs. 10,00,000 soon – please read on)

For all the details on taxation of gratuity proceeds, please read “Income Tax (IT) treatment of gratuity proceeds and calculation of exemption”.

What does this increase in limit mean to you?

Through the “Payment of Gratuity (Amendment) Act 2010”, the limit of maximum payable gratuity has been raised to Rs. 10,00,000 (from Rs. 3,50,000). What does it mean to you? It means that you would now possibly get a higher amount of gratuity payout!

Here are some points to note:

  • This change would impact you only if your gratuity payout is expected to be more than Rs. 3,50,000
  • This change would not impact you if you are a frequent job hopper – if you change jobs before completing 5 years in a company, you would not be entitled to any gratuity at all
  • If your company didn’t have an upper limit on gratuity earlier, you would be unaffected by this change

Should you be doing anything now that the limit has been raised to Rs. 10 Lakhs?

This change is automatic – you do not have to do anything to get the benefit of this increased gratuity limit.

However, you can do something to increase your gratuity entitlement – you can renegotiate your Cost to Company (CTC) salary.

Why? As we saw, the amount of gratuity depends on your salary, and the definition of salary for gratuity calculation includes only basic and DA. Thus, if you renegotiate your CTC salary and increase your basic and / or DA, you would get a higher amount as gratuity at the time of resignation or retirement!

But an important component is missing…

The Income Tax (IT) Act still has Rs. 3,50,000 as the maximum tax-free gratuity amount for employees of private companies. This also needs to be increased to Rs. 10,00,000. This is expected to happen soon.

For all the details on taxation of gratuity proceeds, please read “Income Tax (IT) treatment of gratuity proceeds and calculation of exemption”.

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