What is Gratuity?
Background
Gratuity is a lump-sum payment your employer owes you under the Payment of Gratuity Act, 1972, as a reward for continuous, long service — it's a statutory entitlement, not a discretionary bonus. It's separate from your EPF and NPS balances, and usually becomes payable when you resign, retire, or are laid off after at least 5 years of continuous service with the same employer (the 5-year requirement is waived if service ends due to death or disability).
Explanation
For establishments covered under the Act, gratuity = (15 × last drawn basic + DA × completed years of service) ÷ 26 — the 26 represents working days in a month, and 15 represents half a month's wage per year of service. Service is rounded to the nearest year if the extra period exceeds 6 months (so 10 years 7 months counts as 11 years). The full amount isn't automatically tax-free: the government caps the tax-exempt portion at ₹20 lakh (across your career, not per employer); anything paid above that is taxed as salary income in the year you receive it. Gratuity typically lands as a lump sum around retirement or a job change, separate from your monthly salary, so it's easy to treat as "extra" money rather than folding it into your retirement corpus.
Example
On a ₹60,000 last-drawn basic + DA with 20 years of service: 15/26 × 60,000 × 20 ≈ ₹6.92 lakh — comfortably under the ₹20 lakh exempt limit, so it's fully tax-free. On a ₹1.5 lakh basic + DA with 30 years of service: 15/26 × 1,50,000 × 30 ≈ ₹25.96 lakh — here roughly ₹5.96 lakh crosses the exempt limit and gets added to your taxable income for that year. Either way, gratuity is usually best treated as a one-time addition to your retirement corpus rather than discretionary spending — see the Retirement Planner for how a lump sum like this changes your overall retirement math.
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