Severance pay is a one-time payment made by an employer to an employee upon termination of the employment relationship. A statutory entitlement exists only in specific cases – for example, in the event of an operational redundancy under § 1a of the German Dismissal Protection Act (KSchG), or by court order under § 9 KSchG. In many cases, the amount is negotiated individually as part of a termination agreement or social compensation plan, and it is subject to special tax treatment under the so-called "one-fifth rule" (Fünftelregelung).
What Is Severance Pay?
Severance pay is a lump-sum payment made by an employer to an employee when their employment ends. It serves as financial compensation for the employee's waiver of continued employment or the right to bring legal action.
The concept is rooted in German employment law. Importantly, severance pay is not a reward for work already performed – that has already been compensated through salary. Rather, it is a settlement that brings both parties to a clearly defined conclusion.
Distinction from related terms:
- Termination agreement (Aufhebungsvertrag): The contract that governs the end of the employment relationship – severance is often included, but not automatically so.
- Compensation (Entschädigung): A payment for suffered harm (e.g., in cases of discrimination under the German General Equal Treatment Act, AGG) – legally distinct from severance pay.
- Social compensation plan (Sozialplan): An agreement between the employer and the works council that collectively regulates severance and other benefits in the event of operational changes or mass redundancies.
When Is There an Entitlement to Severance Pay?
This is the key question for HR professionals: in Germany, there is no general statutory entitlement to severance pay. The legal basis depends on the individual case.
Entitlement under § 1a KSchG – Operational Redundancy
This is the most common route in practice. Under § 1a of the Dismissal Protection Act (KSchG), an employer may include a severance offer in the termination notice. The conditions: the dismissal must be operationally motivated, and the employee must allow the three-week period for filing a wrongful dismissal claim to lapse without taking legal action. The legally anchored amount in this case is 0.5 monthly salaries per year of service.
Entitlement under §§ 9, 10 KSchG – Court Order
If an employment tribunal finds that a dismissal was legally invalid but that continued employment would be unreasonable for one of the parties, the court may dissolve the employment relationship in exchange for a severance payment. Under § 10 KSchG, the maximum amount is 12 monthly salaries, or up to 18 monthly salaries in certain cases (for employees over 50 with long service records).
Contractual Entitlement: Termination Agreement, Social Plan, Collective Agreement
The most common form in practice is a mutually agreed settlement within a termination agreement, where both parties freely negotiate the amount and terms. Entitlements to severance may also be set out in social compensation plans (for operational changes, governed by § 112 of the Works Constitution Act, BetrVG) or in collective bargaining agreements.
No Entitlement as a General Rule
An ordinary dismissal – even if unlawful – does not in itself give rise to a severance entitlement. Employees who fail to bring a claim following an invalid dismissal generally also lose their right to reinstatement, without automatically receiving severance in return.
How Is Severance Pay Calculated?
There is no universally prescribed statutory calculation formula – with the exception of the § 1a KSchG route. In practice, however, a widely used rule of thumb has established itself:
0.5 monthly salaries × number of years of service = severance pay
Calculation Example
This formula is a starting point for negotiations, not a legally binding guideline. In practice, severance amounts may deviate upward or downward – depending on negotiating strength, industry, and the prospects of a successful wrongful dismissal claim.
Factors Influencing the Severance Amount
- Length of service: Generally, the longer the tenure, the higher the severance
- Age: Older employees often face a more difficult labour market – this strengthens their negotiating position
- Strength of dismissal protection: The more clearly unlawful the dismissal, the greater the employee's negotiating leverage
- Industry and company size: Severance tends to be higher in larger corporations
- Presence of a works council: Social plan negotiations can significantly increase severance payments
Severance Pay and Taxation
The Basic Rule: Severance Pay Is Taxable
Severance pay is subject to income tax in Germany. Under the Income Tax Act (EStG), it counts as income from non-self-employed work. Although severance pay is no longer exempt from social security contributions in principle (this exemption was abolished in 2006), in practice no contributions to health, long-term care, pension, or unemployment insurance are levied, as severance pay does not constitute contributory remuneration under social security law.
The One-Fifth Rule under § 34 EStG
To mitigate the tax burden, severance payments in many cases benefit from the one-fifth rule (Fünftelregelung) under § 34 of the Income Tax Act (EStG). This applies when the severance constitutes "extraordinary income" – that is, a bundled payment covering multiple years of income.
How the one-fifth rule works:
- The regular annual income (excluding severance) is taken as the baseline.
- One fifth of the severance amount is added to the annual income.
- The resulting additional tax is multiplied by five.
- This figure represents the actual tax liability on the severance payment.
Effect: The effective tax rate on the severance is lower than it would be if the full amount were taxed at the marginal rate. The precise tax impact depends on the individual's income level – advice from a tax professional is recommended.
Severance Pay and Unemployment Benefits
HR professionals should be aware of the implications a severance payment may have for an employee's entitlement to German unemployment benefit I (Arbeitslosengeld I, ALG I).
Disqualification Period with Termination Agreements
If employees sign a termination agreement and thereby bring the employment relationship to an end themselves (even if the initiative came from the employer), they risk a disqualification period of up to 12 weeks for unemployment benefits under § 159 SGB III. The Federal Employment Agency (Bundesagentur für Arbeit) assesses on a case-by-case basis whether the employee acted of their own volition.
Exception: If the employer had threatened an operational dismissal and the dismissal was, from the employee's perspective, virtually unavoidable, the disqualification period may be waived or shortened.
No Deferral Period under § 1a KSchG
An important clarification: the severance payment itself has not triggered a deferral period for ALG I since the 2004 reform. This means employees can apply for unemployment benefits immediately after the end of their employment following an operational redundancy with a severance offer under § 1a KSchG – provided no disqualification period applies.
Negotiating Severance Pay – Tips for HR
Severance negotiations are a sensitive phase for all parties involved. As an HR professional, you can manage the process professionally and fairly:
HR checklist for severance negotiations:
- Assess the legal position: Is there a realistic litigation risk? The stronger the company's legal standing, the lower the required severance offer may be.
- Define a calculation framework: Establish an internal corridor (minimum and maximum offer) based on the rule of thumb and individual factors (age, years of service).
- Act early: An early, fair offer saves costs and avoids lengthy court proceedings.
- Ensure the termination agreement is legally sound: Have the agreement reviewed by a lawyer. Formal errors can render a termination agreement invalid.
- Allow time for consideration: Employees are not required to sign immediately. A reflection period of at least one week is standard practice and demonstrates fairness.
- Communicate the tax implications: Inform employees that they should clarify the tax treatment with a tax advisor.
- Conduct the separation meeting with dignity: The manner in which separations are handled affects employer branding – former employees are brand ambassadors too.
Frequently Asked Questions about Severance Pay
When is there an entitlement to severance pay?
There is no general statutory entitlement. An entitlement arises in three cases: first, under § 1a KSchG, when the employer voluntarily offers severance following an operational dismissal and the employee waives the right to bring a claim; second, through a labour court ruling under §§ 9, 10 KSchG; and third, through individual agreement in a termination agreement, social plan, or collective bargaining agreement.
How is severance pay calculated?
The widely used rule of thumb is: 0.5 monthly salaries multiplied by the number of years of service. With 10 years of service and a gross monthly salary of €4,000, this would amount to €20,000 in severance. This formula is not legally binding – the actual amount is a matter of negotiation and depends on age, length of service, and the legal starting position.
Is severance pay subject to tax?
Yes. Severance payments are subject to income tax. However, no social security contributions are levied. To reduce the tax burden, the one-fifth rule under § 34 EStG frequently applies, resulting in a lower effective tax rate.
What is the one-fifth rule?
The one-fifth rule is a special tax provision under § 34 EStG for extraordinary income such as severance pay. It calculates the tax liability as though the severance were paid out in equal instalments over five years, thereby resulting in a lower tax burden than standard taxation at the marginal rate.
Does receiving severance pay lead to a disqualification period for unemployment benefits?
The severance payment itself does not trigger a disqualification period. However, a disqualification period of up to 12 weeks may arise if the employee terminates the employment relationship through a termination agreement. In the case of an operational dismissal under § 1a KSchG without a termination agreement, there is generally no disqualification period.
Can severance pay be negotiated?
Yes, in principle. Apart from the statutory case under § 1a KSchG, the severance amount is freely negotiable. Key influencing factors include the strength of dismissal protection, the prospects of a successful claim, age, and length of service. Negotiating early and having a clear internal calculation basis helps HR professionals manage the process efficiently.
Severance pay or wrongful dismissal claim – which is the better option?
This depends on the individual situation. Severance pay offers quick certainty and avoids litigation risk. A claim may result in higher payments or reinstatement, but takes longer and carries uncertainty. For HR, the clearer the company's legal position, the greater the room to manoeuvre in negotiations. Legal advice is recommended for both parties.
What must a termination agreement with severance pay contain?
A legally sound termination agreement should include at minimum: the date on which the employment ends, the severance amount and payment date, provisions for any outstanding holiday and overtime, the reference agreement (overall grade and issue date), and a mutual waiver of further claims. Legal review is strongly recommended.
Conclusion
Severance pay is a central instrument in separation management – and at the same time one of the most frequently misunderstood. The key point for HR professionals: there is no automatic entitlement. Severance arises either through statutory provisions (§ 1a KSchG, §§ 9, 10 KSchG), through court rulings, or through freely negotiated agreements in termination agreements or social plans. The calculation follows a well-established rule of thumb, but is always a matter of negotiation. The tax treatment under the one-fifth rule provides meaningful relief for those affected.
A professional, fair separation process not only offers legal protection – it also has a lasting impact on employer branding. Organisations that handle separations with dignity and transparency build long-term trust.
Would you like to select qualified candidates objectively and fairly from the outset, avoiding costly mis-hires and complex separation processes further down the line? Find out more about the science-based talent assessment capabilities of the Aivy platform.
Sources
- § 1a Dismissal Protection Act (KSchG) – Severance entitlement in cases of operational redundancy. Federal Ministry of Justice, 2024. https://www.gesetze-im-internet.de/kschg/__1a.html
- §§ 9, 10 Dismissal Protection Act (KSchG) – Dissolution of the employment relationship by court order / severance amount. Federal Ministry of Justice, 2024. https://www.gesetze-im-internet.de/kschg/
- § 34 Income Tax Act (EStG) – Extraordinary income / one-fifth rule. Federal Ministry of Justice, 2024. https://www.gesetze-im-internet.de/estg/__34.html
- § 159 Social Code Book III (SGB III) – Suspension of entitlement / disqualification period. Federal Ministry of Justice, 2024. https://www.gesetze-im-internet.de/sgb_3/__159.html
- Federal Employment Agency: Information leaflet 1 for unemployed persons – Your rights and obligations. Federal Employment Agency, 2024. https://www.arbeitsagentur.de/datei/merkblatt-1-fuer-arbeitslose_ba015371.pdf
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