Conceptual · Article 7.1.11

Group Gratuity Schemes.

How Employers Pre-Fund a Legal Promise Made to Every Long-Serving Employee.

Published as on 22 July 2026

A Group Gratuity Scheme is a life insurance arrangement, offered by IRDAI-regulated life insurers, that helps an employer systematically fund a legal obligation: paying gratuity to employees under the Payment of Gratuity Act, 1972. The employer — the master policyholder — makes regular contributions into an insurer-managed fund or an approved gratuity trust, which invests the money and pays out when an employee retires, resigns, dies or is disabled. A group term component protects the employer when an employee dies early, before the fund is fully built. This is squarely an employer and HR-benefit decision — not a retail purchase. Contributions are deductible under Section 36(1)(v) up to 8.33% of salary per year; employees enjoy a Section 10(10) exemption up to ₹20 lakh in the private sector.

Employer-Funded

Who Pays

15/26 × Years

Gratuity Formula

₹20 Lakh

Employee Tax-Free Cap

8.33% Cap

Deduction · Sec 36(1)(v)

Executive Summary · Page 2

Executive Summary · 6 Findings

Gratuity is a legal promise, not a perk. Any establishment with 10 or more employees must pay it under the Payment of Gratuity Act, 1972. The only real question for an employer is how that promise is funded: paid from operating cash flows when employees exit, or pre-funded steadily through a Group Gratuity Scheme with a life insurer. The funded route converts a lumpy, unpredictable future outflow into manageable, tax-deductible annual contributions — while insurance covers the shortfall when an employee dies before the fund is built.

Covers what the scheme solves and how the gratuity formula works, the master-policyholder structure and the term-cover component, funded versus unfunded approaches, the three scheme structures (insurer-managed fund, approved gratuity trust, hybrid), employer deductibility under Section 36(1)(v) and employee exemption under Section 10(10), the actuarial-valuation duty under AS-15 and Ind AS 19, the 2025 Social Security Code changes, state-level mandatory insurance, and five questions employers and employees ask.

Key Findings

A statutory liability, systematically pre-funded.

Every establishment with 10 or more employees must pay gratuity to those completing at least five years of continuous service — on retirement, resignation, death or disability. Gratuity is (Basic + DA) × 15/26 × completed years of service. A Group Gratuity Scheme is the employer's tool to build this fund over time with a life insurer, rather than paying from cash flows when employees exit.

The employer is the policyholder; employees are the beneficiaries.

The employer signs the contract with the insurer and is the master policyholder. Employees are members of the scheme — they benefit, but are not parties to the contract and never contribute. The insurer pools and invests the contributions, credits fund growth, and coordinates payouts as employees exit. A group term component bridges the gap when an employee dies before the fund has accumulated the full gratuity owed.

Funded beats unfunded on cash flow and tax.

An unfunded scheme records the liability on the balance sheet but sets aside no money — payouts come from operating cash when employees leave, and no deduction accrues until actually paid. A funded scheme spreads contributions annually, earns investment returns, and — for an approved fund — makes contributions deductible under Section 36(1)(v). It also tames the "bunching" risk of several long-tenured employees retiring at once.

Three structures — insurer-managed, trust, or hybrid.

Most employers use an insurer-managed Group Gratuity Fund: the insurer invests and administers, no separate trust needed. Larger employers may set up an Approved Gratuity Trust — an irrevocable trust under the Indian Trusts Act, 1882, holding funds per the prescribed pattern. A hybrid holds core investments in the trust while buying insurer cover. To qualify for the deduction, the fund must be approved under Part C of the Fourth Schedule to the Income Tax Act.

Two sides of tax: employer deduction, employee exemption.

The employer deducts contributions under Section 36(1)(v), capped at 8.33% of each employee's salary per year, with contributions paid before the return-filing due date (Section 43B). The employee's gratuity is exempt under Section 10(10) — up to ₹20 lakh for the private sector (₹25 lakh for central government civil servants). Income of an approved gratuity trust is itself exempt under Section 10(25)(iv).

The 2025 Social Security Code changes liabilities materially.

Effective 21 November 2025, the Code on Social Security, 2020 reshapes the gratuity base. Where allowances exceed 50% of CTC, the excess is reclassified as wages — lifting the salary base for companies with low-Basic pay structures. Fixed-term employees become eligible after just one year, not five. Actuarial valuations for 31 March 2026 balance sheets must reflect both, and contribution schedules will likely need revising upward.

At A Glance

Metric	Value	Detail
Who funds it	The employer	Employees never contribute
Governing law	Gratuity Act, 1972	10+ employees
Eligibility	5 years' service	Waived on death/disability
Formula	15/26 × years	On Basic + DA
Regulator	IRDAI	Life insurer product
Employer deduction	8.33% cap	Section 36(1)(v)
Employee exemption	₹20 lakh	Section 10(10), private
Nature	HR / employer	Not a retail purchase

Exhibit 01: How the Gratuity Formula Pays Out

Last Basic + DA	Completed Years	Gratuity
₹40,000	10	₹2,30,769
₹80,000	20	₹9,23,077
₹1,20,000	25	₹17,30,769
₹1,50,000	30	₹20,00,000*

*Formula figure is ₹25,96,154 but the statutory maximum caps the payout at ₹20 lakh. Illustrative, using Gratuity = (Basic + DA) × 15/26 × completed years. A company with 500 employees at varying tenures can carry a total gratuity liability of several crore rupees on any given day — the case for systematic pre-funding.

The Opening · Page 3

The Opening

Gratuity begins as a line of law, not a line of marketing. Under the Payment of Gratuity Act, 1972, any establishment with 10 or more employees must pay a lump sum to those who complete at least five years of continuous service, calculated as (Basic + DA) × 15/26 × completed years. An employee retiring after 20 years on a last-drawn Basic of ₹80,000 is owed ₹9,23,077. Multiply that across 500 employees at different stages of their careers and the liability on any single day can run into several crore rupees. The question is never whether to pay — the law settles that. It is whether the money will be there when the moment comes.

"An unfunded gratuity promise is a bill that always arrives — usually in the year a company can least afford it, when its most senior, longest-serving people retire together. A Group Gratuity Scheme turns that shock into a schedule."
A Liability, Made Predictable

The mechanics. The employer enters a Group Gratuity contract with a life insurer and becomes the master policyholder; employees are members and beneficiaries, never contributors. Annual — or more frequent — contributions are credited to a fund, invested across approved asset classes, and grown over time. When an employee exits through retirement, resignation, death or disability, the accumulated fund pays the gratuity due.

Why insurance is part of it. Consider an employee who dies after three years. Death waives the five-year rule, so gratuity is owed — but only three years of contributions have accumulated. A group term component bridges that gap, covering the obligation to the family even before the fund is fully built. The exact basis of this cover varies by insurer and product, which is why employers should confirm its scope when comparing schemes.

The Honest Boundary: A Group Gratuity Scheme is NOT a retail insurance product an individual buys — it is an employer arrangement. It is NOT an employee contribution plan like EPF or NPS — gratuity is 100% the employer's cost. It is NOT a way to escape actuarial valuation — that duty applies whether funded or unfunded. It IS the disciplined, tax-efficient way for an employer to meet a legal promise without cash-flow shocks, provided the fund is approved and the contribution schedule is kept current.

Structure

Part I

What the Scheme Solves, How It Works & Funded vs Unfunded

Part II

The Three Structures & Two-Sided Tax Treatment

Part III

Actuarial Valuation, the 2025 Code & State Mandates

Part IV

The Verdict: A Promise, Funded Before It Falls Due

For the Employer

✓ Smooths a lumpy statutory liability

✓ Deduction under Section 36(1)(v)

✓ Fund earns investment returns

✓ Cover for early-death shortfall

For the Employee

✓ Gratuity is better secured

✓ Family covered on early death

✓ Exempt to ₹20 lakh, Sec 10(10)

✓ No contribution required

Part I

What the Scheme Solves, How It Works, and the Choice Between Funded and Unfunded

The statutory obligation under the Payment of Gratuity Act, 1972 and the formula behind it; the master-policyholder structure and its insurance component; and why setting money aside annually through a life insurer beats paying gratuity from operating cash when employees walk out the door.

Part I · Page 4

What Triggers a Payment

Trigger	5-Year Rule	Paid To
Retirement	Required	Employee
Resignation	Required	Employee
Death	Waived	Nominee
Disability	Waived	Employee

Retirement and resignation require five years of continuous service. Death and permanent disability waive it entirely — gratuity is payable on completed years regardless of tenure, which is precisely the risk the insurance component addresses.

Why the Government's Logic Applies to Employers Too

A Timing Problem, Solved by Pre-Funding

Gratuity accrues quietly, year after year, but falls due in lumps when employees exit — often clustered when a cohort of long-tenured staff retires together. Paying from operating cash makes the outflow hostage to whichever year it lands in. A Group Gratuity Scheme converts that lumpy, unpredictable obligation into a stream of manageable annual contributions, invested and grown by the insurer until they are needed.

Funded vs Unfunded

Aspect	Unfunded	Funded
Money set aside	None	Annual
Deduction	On payment only	Sec 36(1)(v)
Returns	Nil	Fund growth
Cash-flow risk	High (bunching)	Smoothed
Early-death cover	None	Insurer bridges

Many Indian companies, especially smaller ones, run unfunded schemes — recording the liability on the balance sheet (as AS-15 Revised 2005 and Ind AS 19 require) but holding no assets against it. When employees exit, they pay from cash. It is legal outside the states that mandate insurance, but it concentrates risk in the worst possible years.

Where funding earns its keep: a manufacturer whose founding cohort retires within the same three years; a services firm wanting the Section 36(1)(v) deduction its accruing liability cannot yield; an employer in Andhra Pradesh, Telangana or Karnataka where insurance is compulsory. Where it matters less: a very young firm with almost no five-year-tenure staff — though the liability still accrues and must be valued.

Part II

The Three Ways to Structure the Fund, and How Both Sides Are Taxed

Insurer-managed fund, employer-run approved trust, or a hybrid of the two — and the approval that unlocks the deduction; then the two-sided tax picture: the employer's 8.33% deduction under Section 36(1)(v), and the employee's exemption under Section 10(10).

Part II · Page 6

The Three Structures

Insurer-Managed Fund — Most Common

The employer contributes directly to the insurer's Group Gratuity Fund. The insurer pools contributions across employer groups, invests across approved asset classes, credits returns, and administers payouts — no separate trust to run. IRDAI regulates the charges, including fund management fees, so the corpus is not materially eroded over time.

Employer-Managed Approved Gratuity Trust

The employer sets up an irrevocable Approved Gratuity Trust under the Indian Trusts Act, 1882, with trustees from both sides, holding and investing funds per the prescribed pattern. Composition rules vary by state — Karnataka, for instance, requires five members split employer/employee; nationally, at least two India-resident trustees. The trust can itself buy insurer cover, becoming the master policyholder.

The Approval That Unlocks the Deduction

To qualify for the Section 36(1)(v) deduction, the fund must be approved under Part C of the Fourth Schedule to the Income Tax Act, 1961. Major life insurers offering Group Gratuity products maintain this approval. A hybrid model — core investments in the trust, insurer cover alongside — suits larger employers wanting both control and protection.

Taxation (FY 2025-26)

Employer — Section 36(1)(v), 8.33% Cap

Contributions to an approved gratuity fund are deductible as a business expense, capped at 8.33% of each employee's salary (Basic + DA) per year. Past-service funding is subject to the same 8.33% per year of past service. Excess above the cap is not lost — it may be deducted in future years' headroom. Contributions must be paid before the return-filing due date (Section 43B).

Employee — Section 10(10) Exemption

Gratuity received is exempt up to ₹20 lakh for private sector employees (whether or not covered by the Act). Central government civil servants under the CCS (Pension) Rules, 2021 enjoy up to ₹25 lakh (effective 1 January 2024). Amounts above the limit are taxable — as salary for employees, or income from other sources for a nominee. Trust income is exempt under Section 10(25)(iv).

Exemption Limits at a Glance

Category	Tax-Free Limit
Central govt civil servants (CCS Rules)	₹25 lakh
Private sector (covered by Act)	₹20 lakh
Private sector (not covered)	₹20 lakh
Above the limit	Taxable

FY 2025-26. The ₹25 lakh limit applies only to Central government civil servants under CCS/NPS Rules — not to PSUs, state-owned banks, RBI, port trusts, autonomous bodies, universities or state government staff unless separately notified. On death, the same ceilings apply in the nominee's hands.

Part III

Actuarial Valuation, the 2025 Social Security Code, and State Mandates

Why an annual actuarial valuation is non-negotiable under AS-15 and Ind AS 19 whether the scheme is funded or not; how the Code on Social Security, 2020 raises liabilities through the 50% wage rule and one-year eligibility; and the three states where gratuity insurance is already compulsory.

Part III · Page 8

The Non-Negotiable Valuation

AS-15 / Ind AS 19 Apply Regardless

Companies under AS-15 Revised (2005) or Ind AS 19 must obtain an annual actuarial valuation of the gratuity liability — establishing the Present Value of the Defined Benefit Obligation to record in the accounts. This holds whether the scheme is funded or unfunded, at every balance sheet date. Funding does not remove the valuation duty; it simply sets assets against the liability the valuation reveals.

The 2025 Code — Two Changes That Bite

The 50% Wage Rule

From 21 November 2025, where allowances exceed 50% of CTC, the excess is reclassified as wages — so the gratuity base must be at least 50% of CTC. A ₹12,00,000 CTC with Basic at ₹3,60,000 (30%) previously computed gratuity on ₹3,60,000; now the base is at least ₹6,00,000 — a 67% jump for that employee.

One-Year Eligibility for Fixed-Term Staff

Fixed-term contract employees become eligible after just one year of continuous service, not five — expanding the covered workforce. Valuations dated on or after 21 November 2025 must reflect both changes, and 31 March 2026 financial statements must incorporate them. Contribution schedules calibrated to the old structure will likely need revising upward.

State-Level Mandatory Insurance

State	Since	Basis
Andhra Pradesh	2011	State rules
Telangana	2016	Adopted AP rules
Karnataka	Jan 2024	60-day window
Rest of India	Optional	Unfunded allowed

Section 4A of the Act empowers states to mandate compulsory gratuity insurance. Three have done so — Andhra Pradesh, Telangana and Karnataka — requiring a valid policy from LIC or any IRDAI-registered life insurer. Elsewhere, funding from own cash flows (an unfunded scheme) remains legally permissible.

Choosing an Insurer and Sizing the Cover

While IRDAI regulates charges, investment strategy and fund returns vary across insurers — evaluate track record, the debt/equity mix and claim-processing efficiency. On the insurance component, confirm the sum-insured basis per member, whether it fully bridges the fund-to-liability gap, and how it responds when salaries rise materially between enrolment and exit.

The honest truth: the scheme is a funding vehicle, not a compliance shortcut. It does not remove the actuarial-valuation duty, it does not change what the law owes an employee, and it will not fix a liability that has been under-contributed for years. Its value is discipline — turning a legal promise into a funded schedule, with insurance covering the one risk no schedule can plan for: an early death.

Part IV

The Verdict

Fund the promise before it falls due.

Part IV: The Verdict · Page 10

30-Second Summary

Gratuity is a statutory obligation, not an optional benefit: any establishment with 10 or more employees owes it to staff completing five years, calculated as (Basic + DA) × 15/26 × completed years, capped at ₹20 lakh. A Group Gratuity Scheme is an IRDAI-regulated life insurance arrangement that lets an employer pre-fund this liability — the employer is master policyholder, employees are beneficiaries who never contribute, and a group term component covers the shortfall when an employee dies before the fund is built.

The funded route wins on cash flow, on investment returns, and on tax: contributions to an approved fund are deductible under Section 36(1)(v) up to 8.33% of salary per year, while the employee's gratuity is exempt under Section 10(10) to ₹20 lakh. Choose among an insurer-managed fund, an approved trust or a hybrid — and keep the actuarial valuation and contribution schedule current, especially after the Code on Social Security, 2020 raised liabilities from 21 November 2025.

"The law decides that gratuity will be paid. All an employer decides is whether that payment arrives as a planned contribution today or a cash-flow shock tomorrow. A Group Gratuity Scheme is simply the choice to meet a certain future with certainty — and to protect an employee's family against the one date no one can schedule."
The Final Orientation

The Bottom Line: If you employ people who will cross five years, the liability is already yours — value it annually under AS-15 or Ind AS 19 whether or not you fund it. Prefer a funded scheme for the deduction, the investment returns, and the cash-flow discipline; confirm the fund is approved under Part C of the Fourth Schedule so contributions qualify under Section 36(1)(v). Size and verify the insurance component so an early death does not leave a family short. And after the 2025 Social Security Code, engage your actuary and insurer now to reprice liabilities and revise contributions — the 50% wage rule and one-year eligibility raise the bill.

ADWIZR · July 2026

Decision Rules

Fund Through a Scheme If

✓ Long-tenured cohorts near exit

✓ You want the Sec 36(1)(v) deduction

✓ Located in AP, Telangana or Karnataka

✓ You value cash-flow predictability

Common Mistakes

✕ Skipping the actuarial valuation

✕ Using an unapproved fund

✕ Ignoring the 2025 wage rule

✕ Leaving the term cover unsized

Three Misconceptions

What Employers and Employees Get Wrong

(1) "Employees contribute to it." No — gratuity is 100% employer-funded, unlike EPF or NPS. (2) "Funding removes the valuation duty." No — AS-15 / Ind AS 19 valuation is mandatory whether funded or not. (3) "All gratuity is tax-free." Only up to ₹20 lakh for the private sector under Section 10(10); the excess is taxable.

Not a Retail Product

Employer Arrangement vs Individual Cover

A Group Gratuity Scheme is bought by an employer to fund a statutory liability — administered through HR and finance, valued by an actuary. It is not an individual policy an employee purchases, and its "benefit" to the employee is simply that a legal entitlement is better secured. Different tool, different buyer, different purpose.

15/26

Formula

× completed years

8.33%

Deduction cap

Sec 36(1)(v)

₹20L

Employee exempt

Sec 10(10), private

Employer & Employee FAQ

Questions Indian Employers and Employees Ask

Five questions, answered directly.

Employer & Employee FAQ · Page 12

Frequently Asked Questions

Q1 Is a company legally required to take a Group Gratuity Insurance policy?

At the national level the Payment of Gratuity Act, 1972 does not make insurance mandatory — an employer can fund gratuity from its own cash flows. But three states — Andhra Pradesh, Telangana and Karnataka — have used their power under Section 4A of the Act to mandate compulsory gratuity insurance. Employers in those states must hold a valid group gratuity insurance policy from LIC or any IRDAI-registered life insurer.

Q2 We run an unfunded scheme. Should we switch to a funded one?

The funded approach offers clear financial and tax advantages. Annual contributions to an approved Group Gratuity Scheme are deductible under Section 36(1)(v), whereas the unfunded accruing liability is not deductible until paid. A funded scheme also smooths cash-flow risk when long-tenured employees retire in clusters. The Code on Social Security, 2020 changes (effective 21 November 2025) are expected to increase gratuity liabilities materially for companies with low-Basic salary structures, making systematic pre-funding more important than before. An actuary and the life insurer can calculate the catch-up contributions required.

Q3 An employee died after three years. Must the company pay gratuity?

Yes. Death is an exception to the five-year service rule. On the death of an employee the nominee is entitled to gratuity calculated on completed years of service, regardless of whether the five-year threshold was reached. A Group Gratuity Scheme's insurance component covers the shortfall between the accumulated fund and the gratuity owed to the nominee. The nominee's receipt is exempt from income tax up to ₹20 lakh for private sector employees; any excess is taxable as income from other sources.

Q4 How does the 50% CTC wage rule affect our existing scheme?

If Basic pay is below 50% of CTC, the Code on Social Security, 2020 requires the excess allowances to be reclassified as wages for gratuity calculation. This raises the gratuity base and, in turn, the total actuarial liability. An existing contribution schedule calibrated to the old salary structure will likely need to be revised upward. The life insurer and actuarial consultant can recalculate the revised liability and adjust contributions. Companies with fixed-term employees also face expanded coverage, as those staff are now eligible after just one year of service.

Q5 Can employees voluntarily contribute to the scheme?

No. Gratuity is entirely employer-funded under the Payment of Gratuity Act, 1972. Employees do not contribute to a Group Gratuity Scheme. This differs from EPF and NPS, where employees also contribute. The gratuity scheme is one hundred per cent the employer's obligation and cost. What an employee should confirm is that a nomination is on record and that the entitlement is being valued and, ideally, funded.

Q6 What happens to the scheme if the company is acquired or merges?

In a share purchase, the acquirer typically assumes all employee liabilities of the target, including the Group Gratuity Scheme and its accumulated fund — which can be continued, merged with the acquirer's scheme, or restructured. In an asset purchase, treatment depends on whether employees are transferred and whether the acquirer contractually takes on their gratuity history. Either way, it requires legal and actuarial assessment at the time of the transaction.

Q7 Is gratuity received by an NRI who worked in India taxable?

Yes. Gratuity received by an NRI for services rendered in India is taxable in India as salary income sourced from India. The Section 10(10) exemption applies equally — the NRI can claim the ₹20 lakh exemption for private sector employees covered under the Act. Any amount above the exemption is subject to Indian income tax, with tax deducted at source by the employer at the time of payment.

Key Terms & Definitions

Group Gratuity Scheme

An IRDAI-regulated life insurance arrangement through which an employer systematically funds its statutory gratuity liability under the Payment of Gratuity Act, 1972. The employer is master policyholder; employees are members and beneficiaries. It combines a savings/investment fund with a group term insurance component.

Payment of Gratuity Act, 1972

The law making gratuity mandatory in establishments with 10 or more employees, payable to staff completing five years of continuous service (waived on death or disability). Gratuity equals (Basic + DA) × 15/26 × completed years, subject to a ₹20 lakh statutory maximum.

Approved Gratuity Fund

A gratuity fund approved under Part C of the Fourth Schedule to the Income Tax Act, 1961. Approval is what makes employer contributions deductible under Section 36(1)(v). It may be held in an insurer-managed fund or an employer-run irrevocable trust.

Section 36(1)(v)

The provision allowing an employer to deduct contributions to an approved gratuity fund, capped at 8.33% of each employee's salary (Basic + DA) per year. Contributions must be paid before the return-filing due date under Section 43B to qualify in that year.

Section 10(10)

The provision exempting an employee's gratuity from income tax — up to ₹20 lakh for the private sector and ₹25 lakh for central government civil servants under the CCS Rules. Amounts above the limit are taxable in the year of receipt.

Actuarial Valuation

The annual assessment, required under AS-15 Revised (2005) or Ind AS 19, that measures the Present Value of the Defined Benefit Obligation — the gratuity liability recorded on the balance sheet. It is mandatory whether the scheme is funded or unfunded.