How Gratuity Funds Work?

Gratuity is one of the least-attended or least-understood component of an employer’s salary. The following text provides you the necessary information to help you understand everything about gratuity.

What is Gratuity?

Gratuity is a token of gratitude offered by the employer to an employee for the services provided by him/her during the tenure served in the respective company. It is one of the retirement benefits received by the employee. This benefit plan is defined by the employer for the concerned employee, and is paid back to the employee upon quitting. Reasons to quit the job could be many, such as retirement, switching to another job, or being retrenched by the current employer in the form of voluntary retirement. 

Eligibility

As per the Income Tax Act 10 (10), the employee must have completed full-time service of minimum five years in the organisation and minimum 240 days in a year. 

How it Works? 

An employer may offer gratuity out of his own funds or may approach a life insurance company, such as Max Life Insurance, to purchase a group gratuity plan. If the employer chooses to go with an insurance company, then he/she has to opt for an annual contribution to the insurance company as defined by them. The employee also has the right to make contribution to the gratuity fund if he/she wishes to do so. The payment of gratuity by the insurer is based on terms and conditions of the group gratuity scheme. 

Tax Treatment of Gratuity 

The amount received from gratuity is completely tax deductible under the ‘income from salary’ bracket. Also, the gratuity, whether received by the nominee or legal heir of the employee, is always tax deductible under the ‘income from other source’ bracket.