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Gratuity Insurance

By law, the gratuity amount is calculated as 15 days of salary for each year of service. however, if an employee dies in service, the gratuity is calculated as 15 days of salary for each year of ‘potential’ service till retirement. Therefore, in case of demise, gratuity amount is calculated not just on past service rendered by the employee, but also ‘future’ service that the employee could have rendered if he or she had worked till retirement. Therefore, the employer is liable to pay an extra 15 days of salary for each year of future service. The extra payout is insured by paying a risk premium and in case of death is called as future service gratuity

By ensuring future service gratuity, the employer transfers the liability to the insurer. The liability for past service gratuity stays with the employer

By getting into a contract with an insurer, an employer can avail the following benefits:

• Contributions paid to an approved gratuity fund are tax-deductible up to a certain limit
• Investment income earned in the fund is also tax-free
• By investing with an insurance company, employers can invest in certain asset classes which are otherwise restricted if the fund is managed internally, such as equity
• Benefits administration, investment advice, funding advice are provided by the insurer

Deciding whether to fund gratuity liabilities is a long-term strategic decision and a lot of issues need to be considered. We list down some important ‘generic’ issues, which would be applicable to most companies contemplating funding their gratuity schemes.

Tax benefits

From an employer’s perspective, there are three types of tax benefits on offer if the gratuity scheme is funded:

• Annually, an amount equal to 8.33% of basic salaries can be paid into a gratuity fund as a tax-deductible expense.
• If the gratuity liabilities are funded for the first time, a contribution of 8.33% for each year of past service of an employee can be paid into the gratuity fund as a tax-deductible expense.
• Interest or investment income earned within the gratuity fund is also tax-free.

A carefully planned funding strategy can significantly reduce the tax bill of a company. However, tax benefits are not the only consideration for deciding whether to fund a gratuity scheme.

Opportunity cost

For funding gratuity liabilities, companies will need to find cash from within the business and commit to a gratuity trust. Arguably, the most important consideration would be the alternative ways that cash could be put to use and the return that cash would generate and for how long.

When making such a comparison, one thing to remember is that since the interest earned within a gratuity fund is tax-free. Therefore, an expected return of 10% pa is equivalent to 14% pa pre-tax return, after grossing up for tax at 30%.

An example – if a company can invest excess cash into a project that could generate a return of 20% pa for the shareholders consistently for several years and the expected return in gratuity fund is 10% pa (14% pre-tax), then using that cash for gratuity scheme funding would not seem to be an attractive proposition. If the cash is just generating interest income at the bank rate, say 5%, then it would be better off backing gratuity.

Excess cash can be returned to shareholders as dividends, but this option will generally be less attractive than funding, given the tax benefits.

Liquidity management

If liabilities are unfunded, companies will need to pay off the gratuities to leaving employees as and when they leave. Therefore, the amount companies would pay could vary greatly from year to year as the number of people leaving will be uncertain. This would be a concern for small or mid-size companies where the resignation of just a few senior employees, with high salary and service, could create a strain on their cash flow positions. On the other hand, if a scheme is ‘scientifically’ (or actuarially) funded, the fund will build up during the years when no major payouts are paid and then used when large payoffs are required to be paid.

Cashflow stability

For new companies, the gratuity payments to employees would be few and low. However, gratuity payouts increase nearly exponentially as employees age and work longer. By having the liabilities funded, companies can replace the rapidly increasingly gratuity payouts with a relatively stable stream of contributions into the fund.

Cost management

Once funds are set aside to back the gratuity liabilities, a thoughtful investment strategy could go a long way in enhancing the returns and therefore reducing the costs for the employer. Although there is no single strategy that would suit all companies, there are a few things to consider:

• Companies can save on investment management expenses by managing the assets in-house. This is suitable for large companies who can afford to set up an investment management team in-house.
• Small and medium-sized companies would be better off by having a third-party asset manager (such as an insurance company) to manage the funds. This strategy would also help in companies get access to asset classes which they may not be allowed to invest in if managing the fund in-house (e.g. equities).

Ultimately, the decision to fund will depend on how important the above factors are for the company, for meeting their overall business objectives. Generally, new companies often overlook this issue as there are other more pressing issues to consider. However, even for small and new companies, there is a lot to gain from better liquidity and stability. Larger companies will have a lot to gain from the tax benefits on offer.

Documents:

• Age of Employee
• Date of Birth of employee
• Date of Joining.
• Salary + DA.
• Age of retirement

Gratuity Expense is recognised from the day employee joins the company because the gratuity benefits start accruing as soon as the employee starts his/her service. Gratuity provision needs to be made for each employee as on the balance sheet date, irrespective of whether the employee has completed 5 years or not. Also, there is no vesting condition on demise, hence employer is liable to pay gratuity in case of demise even if the employee has not completed 5 years of service.

Actuarial valuation considers the likelihood that gratuity benefit payment may not arise if an employee resigns or retires before the vesting date. Thus, the provision for gratuity is reduced to that extent. The cost of retirement benefits is accounted for in the period during which qualifying services are rendered as gratuity liability starts accruing.

Contribution consists of two parts:-

Past service:- The contributions to provide for the past service liability of the employees can be made based on Actuarial valuation done by Bajaj Allianz. The Past Service contribution can be paid in lump sum or in easy instalments (Maximum 5 instalments)

Annual Contribution:- The Annual contribution will be calculated actuarially every year after considering the funds and liability position on the annual renewal date.

1. For future service gratuity – Insurer will charge the mortality rate which is like life insurance policies. Usually, Rs.1 per 1000 sum insured.

2. Fund Management Charge – usually 0.5% to 1.25% per year

3. Premium allocation charge – Usually around 0% to 2%

Section18 of the Apprenticeship Act excludes an apprentice from the purview of Labor Laws, therefore making an apprentice ineligible for Gratuity.

The logic behind this is the fact that an apprentice is primarily undergoing training to acquire some skills. This is therefore looked at, as a learning contract and not like an employment contract.

So, if you are an apprentice undergoing training, you might not be eligible for Gratuity.

No.
If there is no break in the period of your employment i.e. you join the Organisation as a permanent employee, immediately after completion of your training, you classify for Gratuity right from the day you started your training.