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A Guide for Investment of Gratuity Funds

Read more to know about the proper guide for investment of gratuity funds in a seamless manner.

A gratuity funds consultant’s role in creating an approved gratuity trust is discussed in this article. Along with factors that affect gratuity benefits, accounting requirements for gratuity benefits, tax benefits available to businesses under the pay-as-you-go option, funding options, and gratuity benefits. A choice to establish a gratuity system might benefit the companies greatly in the appropriate conditions. Employers must pay employees who have worked for them for at least five years with a lump payment as a statutory reward known as a gratuity. 

Contrary to other benefits like pay, bonuses, and life insurance, workers only receive a gratuity when they leave the company and not while they are still there. The topics to think about while deciding whether to support a gratuity system are covered in this piece. We have a separate article with answers to some frequently asked questions for projects that have already received funding. Another article here addresses common misconceptions concerning gratuity funds maintained by insurers. If the gratuity amount is not paid within 30 days, the employer will pay the employee the total amount plus simple interest for the time the payment was not made.


Although there are a multiple issues when it comes to considering for funding and gratuity schemes, but to make it easy for you, here we have stated the 5 issues which are the most common and effective ones:

1. Accounting and Frauds

Companies must account for the accrued gratuities to their employees as a liability in their financial statements. Even though liability is noted in the financial statements, corporations are not now obligated to reserve money to support these obligations. As a result, many businesses operate “unfunded” gratuity programs with no underlying assets. A plan with money set aside is referred to as a “financed” plan.

Companies have the option to reserve money to cover their gratuity obligations. Companies may decide to retain a level of funding that they are comfortable with because the current regulatory framework in India does not specify the number of funds that must be maintained. Additionally, businesses can decide how much money they want to put into the fund. 

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Things to Think About for Financing a Gratuity Scheme

This article outlines some significant “generic” difficulties that most businesses should consider while funding their gratuity programs.

Graduality Advantages

In the Indian context, gratuity is a significant retirement benefit for employees and applies to all enterprises (including MNCs, schools, and other corporate entities) with more than ten employees. Since an employee gives up valuable time in his life for his employer’s growth, prosperity, and improvement, the employer gratuitously compensates the employee after he has stopped working for him. Paying gratuity to employees is a legal requirement that falls on the employer’s shoulders as soon as it becomes due.

Companies will need to pay out the gratuity funds to departing employees as and when they leave if gratuity benefits are not paid. Therefore, because it will be difficult to predict how many employees will leave, the amount that employers would pay could differ dramatically from year to year.

Tax Advantages

Three different tax benefits are available to an employer if a gratuity system is funded:

  • Annual contributions to a gratuity fund are allowable as a tax-deductible expense up to an amount equal to 8.33% of basic salary.
  • A well-thought-out finance strategy can dramatically lower a company’s tax burden. 

Optional Cost

Companies must agree to a gratuity trust and raise money from within the company to cover their gratuity liabilities. The alternative uses for the money, as well as the return and duration of that return, could be considered to be the most crucial factors. One item to remember while conducting such a comparison is that interest collected within a gratuity fund is tax-free. Therefore, after grossing up for tax at 30%, a 10% annual return is comparable to a 14% pre-tax return.

As an illustration, if a company has extra cash, it can invest in a project that could yield a return of 20% pa for shareholders consistently over several years. Still, the expected return on the gratuity fund is only 10% pa (14% pre-tax); using that cash to fund the gratuity scheme would not appear appealing. It would be preferable to back gratuities if the cash only earned interest income at the bank rate of 5%. Dividend payments can be sent to shareholders with excess cash, but funding is typically more appealing given the tax advantages.

Liquidity Control

Companies must pay off the gratuities to departing employees when they leave if liabilities are not covered. As a result, because it will be unpredictable how many employees will leave, the amount that employers will pay could differ significantly from year to year. This would be especially problematic for small or mid-sized businesses because even the departure of a small number of senior personnel with long tenures and high salaries might burden their cash flow. 

Cash Flow Consistency

The gratuities paid to employees by new businesses would be rare and minor. However, as workers get older and work more hours, gratuity payments rise almost tenfold. 

Controlling Costs

Once money has been set aside to cover the gratuity liabilities, a well-thought-out investment plan could significantly improve returns while lowering costs for the employer. No one plan would work for all businesses, but there are a few aspects to take into account:

By handling asset management in-house, businesses can reduce their investment management costs. This is appropriate for large businesses that can afford to put up an in-house investment management staff. Additionally, by using this method, businesses might access asset classes they otherwise might not be able to.


In the end, whether or not to provide funding will rely on how crucial the elements mentioned above are to the organization in achieving its overall business goals. In general, new businesses frequently ignore this problem because there are more important matters to think about. However, even tiny and newly established businesses benefit greatly from increased liquidity and stability. Larger businesses stand to gain significantly from the available tax advantages.

If you want to know more about on how to go about investments of gratuity funds, then you are at the right place as Vakilsearch could of great help here.

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