Gratuity: the five-year cliff and the formula behind it

Gratuity is the one component of your CTC that your employer shows you every year and pays you only once — if you last long enough to earn it. It is a statutory lump sum for continuous service, it runs on a formula with an odd-looking denominator, and it has a cliff at five years that has cost a great many people a great deal of money by four months.

The formula, and why 26

For an employee covered by the Payment of Gratuity Act:

Gratuity = last drawn monthly salary × 15 ÷ 26 × completed years of service

"Last drawn salary" means basic plus dearness allowance — not your gross, not your CTC. The 15 is fifteen days of wages per completed year. The 26 is working days in a month, the Act's assumption that a month contains twenty-six payable days rather than thirty. So each year of service earns you a little over half a month's basic. The gratuity calculator applies this directly.

Two rounding rules that matter more than they look:

• Service is counted in completed years, with a part-year over six months rounding up. Four years and seven months counts as five. Four years and five months counts as four — and, as below, as nothing at all.
• A statutory ceiling caps the exempt amount. Anything an employer pays above it is taxable salary in your hands.

The five-year cliff

Gratuity is payable on resignation, retirement or death only after five years of continuous service with the same employer. There is no pro-rata below it. Four years and eleven months earns exactly nothing.

This is the single most expensive detail in the whole arrangement, and it is the reason gratuity deserves a line in a resignation decision that a CTC comparison will not show you. If you are four and a half years in and weighing a move, the number you are walking away from is real, it is calculable, and it belongs in the comparison next to the salary difference.

The five-year condition is waived where service ends because of death or disablement. It does not carry across employers: changing jobs restarts the clock, which is why a career of three-year stints can produce a working life with no gratuity in it at all.

What to do with it

A gratuity payout arrives as a lump sum at exactly the moment your income stops — a job change, or retirement. That timing is the whole planning problem, and it is the same one covered in how to invest a windfall: the money is not special because of where it came from, and the temptation to treat it as found money is what usually disposes of it.

At retirement it is one of the pots feeding a decumulation plan, alongside EPF, the NPS lump sum and whatever portfolio you built beside them — the sequencing question is which pot to draw first.

⚠️ The gratuity exemption ceiling, the coverage thresholds of the Payment of Gratuity Act, and the treatment of part-years have all been amended over time. Verify the current limits with your employer or a tax professional before relying on a figure — WealthTicker is not a SEBI-registered investment adviser.

Key takeaway

Fifteen days of basic per completed year, divided by twenty-six, payable only after five continuous years with one employer — with no pro-rata below the cliff and a statutory cap on the exempt amount above it. It shows in your CTC from day one and vests on day 1,826. If you are close to that line and thinking about leaving, work out the number before you decide.