Mastering Gratuity Calculation: The Step-by-Step Formula

Mastering Gratuity Calculation: The Step-by-Step Formula

At the end of your long and successful career, you look forward to your retirement perks. Your savings and investments grab more than a fair share of your attention. Among these is gratuity, a well-deserved reward for your dedicated service. If you have never bothered to figure out during your work about the money you were quietly putting aside, you could be in for a surprise. To ensure you receive the right amount, it is essential to understand this term, the process behind calculating the gratuity amount, and the tax implications. Know where you stand financially by using the gratuity calculator and plan further investments according to your financial goals and needs. 

What is gratuity?

Gratuity is the sum of money an employer gives you to express appreciation for your continuous service in a specific organization. This sum is typically included as part of your overall compensation but is only disbursed if you complete five consecutive years of service.

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Employers can pay gratuity directly from their funds or through a gratuity insurance provider. In the latter case, the employer consistently contributes a predetermined amount to the group insurance plan. The Payment of Gratuity Act, 1972 governs the calculation and payment of gratuity in India.

What are the eligibility requirements for gratuity?

You qualify for gratuity benefits only if you meet the following criteria.

  • You qualify for a superannuation fund.
  • You choose to resign after dedicating a minimum of five years to the respective organisation.
  • You retire from the company.
  • In an unfortunate circumstance, you experience a disability or become severely ill, rendering it impossible to continue your employment.
  • The employee dies during the employment tenure. In this case, the gratuity is payable to the nominee.

Note: Irrespective of the duration of your continuous service, you will not be eligible for gratuity if you are employed on a contract basis rather than as a permanent employee.

Gratuity calculation formula

To calculate gratuity, you need to know the following formula:

Gratuity = (Basic Salary + Dearness Allowance) x Number of Completed Years of Service x 15/26

Let's break down this formula to understand it better:

  • Basic salary: This is the fixed portion of your salary that does not include any additional allowances or benefits.
  • Dearness allowance: It refers to an allowance paid to employees to offset the impact of inflation.
  • Number of completed years of service: The total number of years and months of service you have met with your employer.

Note: In case your organisation is not covered under the Payment of Gratuity Act, the formula would be {(Basic Salary + Dearness Allowance) x Number of Completed Years of Service x 15/26}

A real-life example 

To illustrate the calculation, let's consider the case of Ramesh, who worked for XYZ Pvt. Ltd. for ten years and six months. His basic salary is Rs 50,000, and his dearness allowance is Rs 10,000.

Gratuity = (50,000 + 10,000) x 10 x 15/26 = 60,000 x 10 x 15/26 = 3,46,153.85

In this example, Ramesh would be eligible to receive Rs 3,46,153.85 as gratuity upon leaving XYZ Pvt. Ltd.

Key considerations 

While calculating gratuity, it is essential to keep the following points in mind:

  • Continuous service: Gratuity is payable only if you have completed at least five years of continuous service with the same employer. However, there are exceptions when gratuity may be paid before completing five years, such as death or disability.
  • Monthly salary calculation: If your salary is calculated daily or weekly, it must be converted into a monthly salary to determine gratuity. Divide your daily or weekly salary by 26 for the equivalent monthly salary.
  • Fractional year calculation: When calculating the number of years of service, any part of a year exceeding six months is considered an entire year. For example, completing seven years and eight months of service will be regarded as eight years for gratuity calculation.

Gratuity tax implications 

Now that you have learned how to calculate the gratuity amount, it's time to understand the tax implications of this payment.

  • Government employees: If you are working under central, state, or local government or are employed in the defence sector, the gratuity you receive is tax-exempt.
  • Private sector employees: If you are working in a private company, the least of the following qualifies for exemption under gratuity provisions:
  • Gratuity amount of Rs 20 lakh
  • Actual gratuity received
  • Last drawn salary inclusive of DA multiplied by employment duration and output multiplied by the number of working days in a month. 
  • Employees not covered under the Gratuity Act: In this scenario, the least of the following is subject to tax exemption:
  • Gratuity amount of Rs 20 lakh
  • Actual gratuity received
  • The last ten months' average basic salary inclusive of DA multiplied by employment tenure and the output multiplied by half month's salary.

Note: Before March 29, 2018, the exemption limit stood at Rs 10 lakh.


You can ensure accurate gratuity calculations by understanding the formula and components involved. Remember, gratuity serves as an effective financial support system, providing a sense of security during retirement or career changes.

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