Wednesday, February 2, 2011

Gratuity Benefits

What is Gratuity ?
It is a lump-sum amount paid to an employee on exit or retirement. Companies use gratuity as a retention tool.

Who is Eligible ?
You get gratuity if you have completed five years in a company. But there is a cap of 10 lakh INR.

Are you ruing your decision not to change jobs while your peers jumped more than two or three times to land fatter salaries? Don't worry, because patience is not only a virtue but can also be very rewarding in financial terms. If you have completed at least five years of service, you are eligible for a fat lump-sum payment in the form of gratuity when yo are finally bidding farewell to a company. Your former colleagues, who changed every two or three years for lucrative new offers, will not be eligible for the same benefit.

Gratuity is one of the oldest employee-retention tool in the basket of HR managers. The objective was to make it lucrative for an employee to stay in the company in the long term and reap benefits. However, the gratuity has lost flavor over the years because job-hopping has become a norm.

Besides, patience is in short supply in this era of instant gratification. Young stars today are more concerned with cash in hand than what comes to them after 10-20 years. They do not think of long-term benefits and give no significance to benefits such as gratuity.

This can be a costly judgement error. Even with a small hike in your basic salary, your gratuity corpus can assume gigantic proportions over the long term. If someone starts his career at a basic salary of Rs.30,000 and get a nominal 10% increase every year, his gratuity at the end of 20 years will be Rs 14.1 lakh. However, the Payment of Gratuity Act, 1972, places a cap of Rs 10 lakh on the amount that a company has to pay as gratuity, although a company is free to give more if it wants to.

What's more, the tax exemption limit for gratuity has now been raised to Rs.10 lakh, which makes this long-term benefit even more attractive. Governed by the Payment of Gratuity Act, 1972, gratuity is a defined benefit plan. It is mandatory for companies with more than 10 employees on their payrolls to give gratuity to an employee on resignation, retirement and termination of service. However, an employee is eligible for this benefit only on completion of five years of continuous service with the company. Say, you leave after working for three years and rejoin after sometime and work for another two years, you are not entitled to this benefit.

But there are exceptions to this rule. The condition of minimum five years of service is relaxed in the case of death or permanent disablement of the employee.

How Gratuity is calculated?
It is calculated as 15 days' salary for each completed year of service. This salary includes your last drawn basic salary and dearness allowance(if any) but excludes all other allowances. For instance, if you have completed seven years of service and the last drawn monthly salary is Rs.45,000, you are entitled to a gratuity of Rs1.8 lakh (tax free). The gratuity rules are lenient when it comes to calculating the completed years of service. If one has put in more than six months during a year, it shall be treated as one complete year.

How Gratuity is taxed
Tax exemption to gratuity is the least of the following:
  1. Actual amount received. 
  2. 15 days' salary for each year of service
  3. Rs 10 lakh
No tax for government employees Gratuity rules are skewed in favour of government employees. For them, gratuity is fully exempt from income tax. For private sector employees, gratuity is exempt up to Rs 10 lakh. This limit has recently been raised from Rs 3.5 lakh earlier to make gratuity more attractive.

Tax free limit This Rs 10 lakh is the combined limit for the gratuity amount received by an individual over a lifetime. If you have received Rs 3.5 lakh as gratuity from a previous employer and get another Rs 8 lakh from the next employer, only Rs 6.5 lakh of the second payment will be tax-free. The balance Rs 1.5 lakh will be taxed as income.

Gratuity on death In case gratuity is paid on the death of an employee, the amount received by a nominee is tax-free subject to maximum exemption of Rs 10 lakh.

Excess payment If a company pays more that the gratuity amount as per the calculation given in the Gratuity Act, 1972, the excess amount is taxed as income at the applicable rate. If the gratuity adds up to Rs 8 lakh but the company pays the employee Rs 10 lakh, the excess Rs 2 lakh will be taxed even though it is within the tax free limit.

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