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Gratuity Formula Explained: How Employee Benefits Are Computed in India

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GRATUITY



    The gratuity formula is a standardized method used to calculate the amount an employer must pay an eligible employee upon termination of employment.

 

    The most widely applicable formula in India, used for private sector employees covered under the Code on Social Security, 2020, is: 

Gratuity=15×Last Drawn Monthly Wages×Completed Years of Service/26

Here is a full explanation of how the formula works and what each component means: 

Formula Breakdown and Explanation 

    The formula ensures an employee receives 15 days' worth of wages for every completed year of service they have provided to the company. 

1. Last Drawn Monthly Wages 

    This is the most critical component. It is the full monthly salary the employee received in their last working month. Under the new labour codes effective November 21, 2025, "Wages" is specifically defined to be inclusive of: 

  • Basic Pay
  • Dearness Allowance (DA)
  • Retaining Allowance (if any) 

Important Update (50% Rule):

    The new labour laws mandate that the sum of these core components (Basic + DA + Retaining Allowance) must constitute at least 50% of the employee's total gross monthly compensation (CTC). 

  • If your current salary structure has allowances (like HRA, LTA, Conveyance) that push the basic pay below 50% of the total, the employer must recalculate the "wages" by adding the excess allowance amount back into the basic pay for the gratuity calculation. This generally results in a higher gratuity payout. 

2. 15 

    This constant represents 15 days of wages. The law calculates the gratuity benefit based on half a month's salary for every year worked. 

3. 26 

    This constant represents the average number of working days in a month. By dividing the monthly wage by 26, we find the daily wage rate of the employee. 

4. Completed Years of Service 

    This refers to the total number of full years the employee has worked for that specific employer. The calculation has a rounding rule: 

  • If an employee completes a full year plus six months or more, the service period is rounded up to the next full year.

    • Example: 4 years and 7 months is counted as 5 years.
    • Example: 4 years and 5 months is counted as 4 years. 

Eligibility Requirements 

To receive this payout, an employee must meet specific eligibility criteria: 

  • Permanent Employees: Must complete at least five years of continuous service with the same employer.
  • Fixed-Term/Contract Employees: Must complete at least one year of continuous service (pro-rata entitlement).
  • The five-year minimum service condition is waived if the termination of employment is due to the employee's death or disablement (accident or disease). 

Example Calculation 



Let's assume an employee, Ramesh, has: 

  • Last Drawn Monthly Wages (Basic + DA): ₹50,000
  • Total Completed Service: 10 years and 8 months (rounded up to 11 years) 

Calculation: 

Gratuity=15×50,000×11/26

Gratuity=8,250,000/26

Ramesh's Gratuity = ₹3,17,307.69 

This entire amount is tax-free up to the maximum government limit of ₹20 Lakhs for private sector employees. 

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