Gratuity Calculation, Meaning & Eligibility Details

Motivation is the key to better performance. Employers occasionally acknowledge their employees for their efforts, either financially or in other ways. Gratuity is one of them.  According to the Payment of Gratuity Act of 1972, companies pay a sum of money to their long-term employees who have rendered their services for 5 consecutive years. Read on to find out more about eligibility, the formula, and how to calculate your gratuity amount. 

What Do You Mean By Gratuity in Salary? 

An employee may get a gratuity from their employer as compensation for the services they have provided to the company. It is a portion of the income an employee gets and can be considered a retirement plan. When an employee resigns from a position after working for the same company for at least five years, the business must pay a gratuity. It might be considered a token of recognition from the employer to the employee for their ongoing service.

Eligibility Criteria Of Gratuity

The following are the circumstances in which an employer is required to pay a gratuity to its employees. 

• A worker ought to be qualified for a pension.
• Retirement of employee
• When an employee resigns after working 5 years continuously with one employer. 
• An employee dies suddenly or becomes disabled as a result of disease or an accident.

How Do You Calculate the Gratuity Amount? 

The gratuity amount is calculated on the basis of total working years with the company and the last salary received. Therefore, you can calculate the gratuity amount with the help of the following formula: 

Gratuity= Total Number of Years in a Company * Last Drawn Basic Salary + Dearness allowance * 15/26

Let’s understand in detail with the help of an example. Rajat, an IT employee, has been working for 20 years, and his last withdrawn basic plus DA amount is Rs. 25,000. Therefore, according to the above formula, his gratuity amount would be: 

Gratuity amount for Rajat = 20*25,000*15/26 = Rs. 2,88,461.54

The choice to provide an employee with a larger gratuity is up to the company. In addition, the number of months in the most recent year of employment is rounded up to the nearest whole number for months over six and to the nearest whole number for months under six.

Why To Invest Gratuity Amount in Fixed Deposits? 

Gratuity received on retirement can be utilised in numerous ways to create savings and yield wealth. Besides this, a young professional who has rendered five years of service in the same company can invest the gratuity amount in financial instruments such as fixed deposits. It is a financial asset that provides a fixed, high rate of return on investment. Listed below are some of the advantages of investing gratuity amounts in fixed deposits. 

• High Stability of Funds: 

Stock market fluctuations do not affect fixed deposit returns. Furthermore, the interest rate does not change frequently. Thus, it makes it easier for you to calculate your returns. 

• High-Interest Rate: 

There are many financial institutions and banks that provide a high rate of return on fixed deposits. All you need to do is compare the options and choose the most profitable one for you. 

• Flexibility: 

Fixed deposits provide you with the flexibility to choose from different durations. You can either invest your money in the short-term or long-term, between 12 months to 60 months depending on your financial goals. 

• Loan Benefit:

A fixed deposit helps you overcome your unforeseen liabilities and financial emergencies by granting the loan. Any individual can take a loan against FD for up to 75% to pay off liabilities and debts. 

• Regular and Non-cumulative Investment: 

In regular investment which is also known as cumulative investment, an individual creates a corpus of wealth by multiplying compounding interest on principal over time. However, a non-cumulative investment allows you to get returns regularly at the duration chosen by you. 

• Protect Funds Against Inflation: 

You can create a hedge against inflation by investing your gratuity amount in short-term fixed deposits. This will ensure that you gain benefit on different interest rates pertaining during that period of time.

Key Points To Know About Gratuity 

Here are some of the key pointers that you should know about the gratuity amount which is provided by an employer to its employees. 

• An employer may give a gratuity to an employee that exceeds Rs. 10,000,000. In this instance, the tax exemption will be calculated based on the criteria specified under taxation.
• The existing tax-exempted gratuity maximum in India has been raised to Rs. 30 lakhs, according to Mr. Piyush Goyal, the country's current finance minister, who made the announcement in the interim budget for 2019.
• If an employee is asked to quit a position due to misconduct, the employer has the right to refuse payment of the gratuity to the employee.
• If an employee passes away, their beneficiary or a member of their family receives the gratuity payment. The recipient's income tax is computed for this under the category of income from other sources.

Taxation On Gratuity Amount 

Taxation of gratuities is a process that is dependent on the employee who is earning the payment. There are two typical situations that apply to the calculation of gratuity tax:

• A Government Worker Receiving Gratuities: 

Any government employee working for the federal government, a state or a municipal government is qualified to receive gratuities that are entirely exempt from income tax.

• Any Salaried Person other than a government employee receiving a Gratuity from an Employer Covered by the Payment of Gratuity Act: 

Any salaried individual who is not a government employee is eligible to receive tax exemption on the gratuity amount received by the company under the below cases: 

1. 15 days of pay based on the last time the person was paid
2. Individual who is not covered under the Gratuity act and is receiving gratuity from their employer. 

Conclusion 

In conclusion, gratuity is a benefit received to employees for their long-term service at one organisation, say 5 years. Generally, every month a portion of income is withheld by an employer which is further paid to the employee at the time of their resignation as a gratuity amount. An individual can enjoy the benefits of gratuity for up to Rs. 10 lakh irrespective of the number of years they have worked in an organization.

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