Dear Mubashira,
While others have responded to your query, let me add my thoughts as well.
The Policy of your Company is that employees must retire at the age of 58 years. However, it is the desire of the Company to re-employ the person after formal retirement takes place.
There is no statutory requirement for retirement, as far as private companies are concerned. You are free to decide either way (re-employ the person or retain the person as a consultant) and also change the age of retirement as is felt appropriate.
My suggestion is the following:
1. Let the retirement take place, followed by the full and final settlement in the normal course.
2. It is preferable (as suggested by several others already) to retain (not re-employ) the person as a consultant. This would provide continuity and benefit of knowledge that the individual brings to the table. I would not suggest that he be re-employed as an employee, since (apart from having to change the policy) this could be cited as a precedent by others who may retire later and seek re-employment. On the other hand a company is free to appoint anyone as a Consultant - it will not be possible to cite this as a precedent.
3. Regarding the allowances that would have been payable to the employee during his employment period (PF, EDLI, Gratuity etc), you could take a Cost to Company approach i.e., gross up all the allowances payable as a part of salary and pay the person the grossed up amount as consultancy fees. This would make sure that while the individual is no worse off financially but also retains the flexibility to invest the surplus funds in instruments of their choice. Since a consultant is not an employee, the benefits like PF / Gratuity etc would not be payable.
I hope this would help you in arriving at an appropriate decision.
Regards
Raju Bhatnagar