What gratuity is
Gratuity is a lump sum an employer pays as a thank-you for long service, governed by the Payment of Gratuity Act, 1972. It becomes payable when you leave after completing at least 5 years of continuous service — through resignation, retirement, or otherwise — and is one of the few employee benefits with a statutory formula.
The gratuity formula
Gratuity = (15 ÷ 26) × last drawn monthly salary × completed years of service
- Last drawn salary = basic + dearness allowance (DA)
- 15/26 represents 15 days' wages for each completed year, treating a month as 26 working days
- The result is capped at ₹20,00,000, which is also the lifetime tax-free limit
Worked example
Suppose your last drawn basic + DA is ₹60,000 a month and you have completed 10 years of service.
Gratuity = (15 ÷ 26) × 60,000 × 10 = 0.5769 × 60,000 × 10 = ₹3,46,154.
This is well under the ₹20 lakh cap, so the full amount is payable and tax-free. If the formula had produced more than ₹20 lakh — say after very long service on a high salary — the payout would be capped at ₹20,00,000 for tax-free purposes.
Things people get wrong
- Using CTC instead of basic + DA. Gratuity is computed only on basic + DA, so it is usually smaller than people expect from a large CTC.
- Forgetting the 5-year threshold. Leave at 4 years 9 months and, in most cases, no gratuity is due (the death/disability exception aside).
- Ignoring the cap. The ₹20 lakh figure is both the statutory ceiling and the lifetime tax-free limit across employers.
Because gratuity depends on basic salary, a pay structure with a higher basic increases both your gratuity and your EPF — worth keeping in mind when you negotiate or restructure your salary.