What Is Severance Pay and When Is It Paid?
Severance pay (Abfindung) in Germany is a one-time payment from the employer to the employee as compensation for the loss of employment. Contrary to popular belief, there is no general legal entitlement to severance pay in Germany. Most severance payments are negotiated through termination agreements (Aufhebungsverträge), social plans (Sozialpläne), or court settlements before the labor court.
An important exception is Section 1a of the Employment Protection Act (KSchG): In the case of operational dismissal, the employer can offer severance equal to half a gross monthly salary per year of service if the employee waives their right to file an unfair dismissal claim. However, this is merely an offer, not an entitlement.
In practice, the amount of severance is influenced by several factors: length of service, age of the employee, job market prospects, the company's financial situation, and the likelihood of success in a potential unfair dismissal claim.
The Standard Formula: 0.5 x Monthly Salary x Years of Service
The most commonly used calculation method for severance pay is the so-called Faustformel (rule of thumb): half a gross monthly salary multiplied by the number of years of employment. With a monthly salary of €4,000 and 10 years of service, this results in €20,000 gross severance.
This formula is neither legally mandated nor binding — it merely serves as a reference point and starting position for negotiations. The actual factor can vary significantly depending on the situation. In large corporations, for employees with long service periods, or when the employer’s legal position is uncertain, factors of 0.75 to 1.5 or even higher can be achieved.
When calculating years of service, partial years of six months or more are rounded up. Someone who has been with the company for 9 years and 7 months would be counted as having 10 years of service.
When Severance Goes Higher: Age, Tenure, and Negotiation
Several circumstances can lead to higher severance pay. Older employees over 50 with long tenure generally have a stronger negotiating position because their job market prospects are worse. At 55+ years of age and 20+ years of service, a factor of 1.0 (one full monthly salary per year of service) is not uncommon.
Company size also plays a role: large companies and corporations tend to pay higher severance than mid-sized businesses. In social plans negotiated between works councils and employers during mass layoffs, severance payments can also significantly exceed the standard formula.
Another important factor is the legal situation: if the dismissal is challengeable (e.g., due to inadequate social selection or failure to consult the works council), the employee's negotiating position improves considerably. An unfair dismissal claim can often lead to a settlement with higher severance.
Severance and Taxes: Why the Fifth-Part Rule Is Crucial
Severance payments are subject to income tax — but not to social security contributions. This means no health, pension, nursing care, or unemployment insurance contributions are due on the severance. For tax purposes, severance payments are treated as extraordinary income, to which the so-called fifth-part rule (Fünftelregelung) under Section 34 of the Income Tax Act (EStG) applies.
The fifth-part rule mitigates the progressive tax effect: instead of adding the entire severance to regular income (which would significantly push up the tax rate), only one-fifth of the severance is added to income. The resulting additional tax is then multiplied by five. Since the tax rate for the lower income is lower, this results in significant tax savings.
Calculation Example: €40,000 Severance With and Without the Fifth-Part Rule
Consider an employee with €48,000 annual income in tax class I who receives €40,000 severance. Without the fifth-part rule, their taxable income would rise to €88,000, resulting in a significantly higher tax burden. With the fifth-part rule, only 1/5 of the severance (€8,000) is added to income, the additional tax is determined, and multiplied by 5. The savings can amount to several thousand euros depending on the income situation.
Important: The fifth-part rule only works if the severance is paid in a single calendar year. With installment payments over multiple years, the tax advantage is lost. There must also be a so-called concentration of income — the severance must exceed the regular income that was lost due to the job loss in that calendar year.
Social Security: Severance Is Contribution-Free
An important advantage: genuine severance payments made as compensation for job loss are exempt from social security contributions. No health, pension, nursing care, or unemployment insurance contributions apply. This applies regardless of the severance amount.
However, caution is advised if salary components (e.g., outstanding overtime, vacation pay, or bonuses) are included in the severance. These portions may be subject to social security contributions. It is therefore advisable to clearly separate severance from salary components in the termination agreement.
Severance and Unemployment Benefits Waiting Period
A common misconception: the severance itself does not reduce unemployment benefits. However, the manner of termination can trigger a waiting period. Anyone who agrees to a termination agreement risks a waiting period of up to 12 weeks for ALG I, as the employment agency assumes voluntary termination.
To avoid a waiting period, the dismissal should come from the employer (operational reasons) and the severance should be agreed in a settlement agreement or court settlement. It is also important that the standard notice period is observed — if the employment ends prematurely, the severance may be partially offset against unemployment benefits.
Tax Optimization Strategies
There are several legal ways to reduce the tax burden on severance. First, transfer to company pension (bAV): parts of the severance can be paid tax-free into a direct insurance policy or pension fund. Second, timing of payment: if other income in the payment year is as low as possible, the fifth-part rule works particularly well. Payment in January of the following year after the end of employment can therefore be advantageous.
Third, for married couples, a tax class change before the severance payment can reduce the tax burden. And fourth, it is worthwhile to claim all possible work-related expenses and special expenses in the year of the severance to reduce taxable income.
Conclusion
Severance pay can represent a substantial financial sum — but only if you understand and optimize the tax implications. Use our severance calculator to work through your personal situation, and for larger amounts, consult a tax advisor or employment law specialist.