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How to Calculate Gratuity: Formula, Steps & Examples



Gratuity is an essential component of employee benefits in many countries, especially in India, where it provides financial security to employees after they complete a long tenure with an employer. Whether you're an employee eager to calculate your own gratuity or an employer seeking to understand how to compute this benefit, understanding the gratuity calculation process is vital. This article will guide you through the steps, provide a clear formula, and even offer examples to help you accurately calculate gratuity.

What is Gratuity?

Gratuity is a lump sum payment made by an employer to an employee, typically after they leave the organization after completing a certain number of years of service. It acts as a reward for the employee's continuous contribution to the organization and provides them with a financial cushion when they retire or move on to a new opportunity.

In India, gratuity is governed by the Payment of Gratuity Act, 1972, which mandates gratuity payments for employees in establishments with 10 or more employees. The payment can be made upon termination, resignation, retirement, or death, provided the employee has worked for a minimum of 5 years.

Gratuity Calculation Formula

To calculate gratuity, the following formula is commonly used:

Gratuity = (Last Drawn Salary × Years of Service × 15) ÷ 26

Where:

  • Last Drawn Salary: This refers to the salary received by the employee in the last month of employment. It typically includes basic salary and dearness allowance (DA).
  • Years of Service: The total years the employee has worked for the organization.
  • 15: This constant represents the 15 days of wages for each year of service (as per the Payment of Gratuity Act).
  • 26: This represents the number of working days in a month (usually assumed to be 26 days for calculating gratuity).

Example 1: Gratuity Calculation

Let’s take an example of an employee who has worked with a company for 10 years. Suppose the last drawn salary (basic + DA) is ₹50,000.

Gratuity = (50,000 × 10 × 15) ÷ 26
Gratuity = ₹2,88,461.54

In this case, the employee is entitled to ₹2,88,461.54 as gratuity.

Gratuity Calculation for Different Scenarios

1. For Employees with Less than 5 Years of Service

Gratuity is only applicable to employees who have completed 5 years or more of continuous service with the employer. If an employee resigns or leaves before completing 5 years, they are not eligible for gratuity under the Payment of Gratuity Act.

However, some companies offer gratuity benefits even for employees who leave earlier, but this is not a legal requirement. It’s important to check the company's policy in such cases.

2. For Employees in Private Sector

Employees working in private companies also follow the same gratuity calculation formula. The key factor to keep in mind is the eligibility criteria, which is 5 years of continuous service.

Gratuity Calculation Formula

The calculation of gratuity is the same, but companies may offer variations in the formula or the conditions of eligibility based on their internal policies.

3. For Government Employees

Government employees have a more straightforward gratuity calculation as compared to those in the private sector. The rules governing gratuity for government employees are slightly different, with some additional benefits. They are also entitled to a higher gratuity payout in some cases, depending on their grade and position.

4. Taxation on Gratuity

Gratuity is generally tax-free up to a certain limit under Section 10(10) of the Income Tax Act, 1961. For non-government employees, the exemption is limited to the least of the following:

  • ₹20,00,000
  • Gratuity received
  • Actual gratuity calculation (as per the formula mentioned)

If the gratuity exceeds the exemption limit, the excess amount is taxable under the head "Income from Salary."

Example 2: Taxation on Gratuity

If an employee’s gratuity is ₹25,00,000, the taxable amount would be ₹5,00,000 (₹25,00,000 - ₹20,00,000).

How to Use a Gratuity Calculator

If you want to make the process even simpler, you can use a gratuity calculator. These calculators are available online and can help you compute gratuity quickly.

Here's how a gratuity calculator works:

  1. Enter the last drawn salary: You will need to input the basic salary and dearness allowance (DA) to calculate the total last drawn salary.
  2. Enter years of service: The calculator will ask for the total number of years you have worked with the company.
  3. Get the gratuity amount: Once the data is entered, the calculator will use the formula and provide you with the gratuity amount you are entitled to.

Table: Gratuity Calculation Example Using Different Salary Figures

Last Drawn Salary (₹)Years of ServiceGratuity Calculation (₹)Gratuity Entitled (₹)
30,0005(30,000 × 5 × 15) ÷ 261,73,076.92
50,00010(50,000 × 10 × 15) ÷ 262,88,461.54
60,00015(60,000 × 15 × 15) ÷ 264,13,846.15

Important Points to Consider in Gratuity Calculation

  1. Salary Components: Only basic salary and dearness allowance (DA) are included in the gratuity calculation. Bonuses, overtime, and other allowances are generally not included.
  2. Partial Year Service: If an employee has worked for more than 6 months but less than a year, the company may consider the employee’s service as a full year while calculating gratuity.
  3. Gratuity and Leave Encashment: In some cases, employees are also entitled to leave encashment, which is the payment for unused leave days. This is typically separate from gratuity.

Conclusion

Calculating gratuity is a straightforward process when you understand the formula and the factors involved. It is an essential benefit that rewards employees for their long-term service. Whether you're an employee calculating your dues or an employer ensuring compliance with the Payment of Gratuity Act, it's crucial to follow the correct procedure to ensure accuracy.

By following the steps and examples shared in this article, you should be able to calculate your gratuity or understand how your employer will calculate it. Using online gratuity calculators can further simplify the process, making it more convenient for employees to plan their finances as they transition to new opportunities or retirement.

FAQ

What is the formula to calculate gratuity?

The gratuity formula is: (Last Drawn Salary × Years of Service × 15) ÷ 26. This gives the gratuity amount an employee is entitled to receive.

Who is eligible for gratuity?

Employees who have completed at least 5 years of continuous service with an employer are eligible for gratuity under the Payment of Gratuity Act, 1972.

Is gratuity taxable?

Gratuity is tax-free up to ₹20 lakh for non-government employees under Section 10(10) of the Income Tax Act. Any amount above that is taxable.

How is gratuity calculated for employees with less than 5 years of service?

Employees with less than 5 years of service are not eligible for gratuity as per the Payment of Gratuity Act, 1972, unless the employer offers gratuity in their policy.

Can gratuity be calculated using an online gratuity calculator?

Yes, you can easily calculate gratuity using an online gratuity calculator by entering your last drawn salary and years of service.

What are the components included in the gratuity calculation?

Only the basic salary and dearness allowance (DA) are included in the gratuity calculation. Bonuses, overtime, and other allowances are not considered.

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