Introduction
Gratuity is a lump-sum amount an employer pays to an employee as a token of appreciation for long-term service. In India, it is governed by the Payment of Gratuity Act, 1972, and forms a key component of retirement and exit benefits.
What Is Gratuity?
Gratuity is a defined benefit paid by employers to employees who have completed at least five years of continuous service with the same organisation. It is payable on:
- Retirement or superannuation
- Resignation after 5+ years
- Death or disablement (5-year rule waived)
- Termination (other than for misconduct)
Eligibility
You are eligible for gratuity under the Act if:
- Your employer has 10 or more employees on any day in the preceding 12 months.
- You have completed 5 years of continuous service (any year with 240+ working days counts as full).
- The 5-year rule does not apply in case of death or permanent disablement.
Gratuity Formula
For employees covered under the Act
$$\text{Gratuity} = \frac{15 \times \text{Last Drawn Salary} \times \text{Years of Service}}{26}$$
Variables
- Last Drawn Salary = Basic + Dearness Allowance (DA)
- 15 = 15 days' wages for each completed year
- 26 = Number of working days in a month (statutory)
- Years of Service = Rounded up if last year ≥ 6 months, else rounded down
For employees not covered under the Act
$$\text{Gratuity} = \frac{15 \times \text{Avg Salary (last 10 months)} \times \text{Years}}{30}$$
Worked Example
Scenario: Last drawn Basic + DA = ₹60,000. Service = 12 years 7 months.
- Years counted = 13 (7 months ≥ 6 → round up)
- Gratuity = (15 × 60,000 × 13) / 26 = ₹4,50,000
Tax Treatment
| Employee Type | Maximum Exempt |
|---|---|
| Government employees | Fully exempt |
| Covered under Act (private) | Least of: ₹20 lakh, actual gratuity, formula amount |
| Not covered | Least of: ₹20 lakh, actual, half-month salary × years |
The lifetime exemption ceiling is ₹20 lakh as notified by the Ministry of Finance.
Benefits
- Tax-efficient retirement lump sum
- Mandatory employer obligation under law
- Provides financial cushion at exit
- Nominee receives amount in case of death
Limitations
- Requires 5-year continuous service (except death/disability)
- Calculated only on Basic + DA, not full CTC
- Capped at ₹20 lakh for tax purposes
- Not portable across employers
Common Mistakes
- Including HRA, bonus or special allowances in the salary base — only Basic + DA count.
- Counting partial years incorrectly — only ≥6 months rounds up.
- Assuming gratuity is paid before completing 5 years.
- Forgetting the ₹20 lakh aggregate lifetime exemption cap.
- Confusing the 26-day divisor (covered) with 30-day (not covered).
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Conclusion
Gratuity is one of the most reliable statutory retirement benefits available to Indian employees. Understanding the formula — and the difference between the 26-day and 30-day divisors — helps you forecast your exit corpus accurately. Use our Gratuity Calculator for instant estimates.