HR-Glossar
Abfindung (severance payment)
When severance is paid in Germany, why there is no statutory entitlement, how it is taxed and what it does to unemployment benefit.
1. What is Abfindung (severance payment)?
An Abfindung is a one-off payment by the employer for the loss of the job. It is not remuneration for work performed but compensation – and all its peculiarities follow from exactly that.
There is no general statutory entitlement. Severance regularly arises from agreement: in a termination agreement, in a court settlement, from a social plan, or from the case in Section 1a KSchG, where the employer offers severance on a redundancy dismissal and the employee in return waives the unfair dismissal claim.
For tax purposes severance is fully taxable employment income. The one-fifth rule in Section 34 EStG may apply to it, mitigating the progression effect of a one-off payment; severance is treated as compensation within the meaning of Section 24 no. 1 EStG. Its application already in withholding has been discontinued; since then it works through the income tax assessment, that is through the employee's tax return.
For social security purposes a genuine severance payment is free of contributions, because it is not remuneration. The condition is that it genuinely compensates the loss of the job and does not disguise outstanding pay.
Anyone arriving with expectations from another jurisdiction should note the first point above. The widely quoted half a month's pay per year of service is a courtroom rule of thumb, not a statutory formula, and it binds nobody.
2. Origin and development
Severance arose as a negotiated solution around dismissal protection. Dismissal protection aims at the preservation of the employment relationship; in practice, after a dismissal dispute, neither side usually wants it any more. Severance is the price of a separation both sides prefer.
The tax treatment was long more generous – there were allowances, which were abolished step by step. What remains is the one-fifth rule as a mitigation of progression. Its move out of withholding and into the assessment changed something tangible for those affected: the tax benefit now arrives with the tax assessment, no longer with the payment.
3. Core principles and how it works
No general entitlement
Whoever wants severance negotiates it – or relies on a social plan, a collective agreement or the statutory offer model on a redundancy dismissal.
Compensation rather than remuneration
Because it does not pay for work, it is free of contributions. Labelling outstanding pay as severance instead does not hold.
The one-fifth rule mitigates progression
The payment is notionally spread over five years to soften the tax effect of the bunching. It presupposes a bunching of income.
Effect on unemployment benefit
A termination agreement can trigger a waiting period. Where the notice period is not observed, the entitlement can additionally be suspended until it would have expired.
Due date and form
The timing and the amount belong clearly agreed. The due date determines which assessment period the payment falls into.
4. Who is Abfindung (severance payment) relevant for?
- Employees in separation situations – for them severance is the commercial heart of the negotiation. - Employers – in restructuring, a social plan or a dismissal dispute. - Works council – directly involved where there is a social plan. - Payroll teams – the calculation requires its own wage types and a clean separation of pay components.
5. How it differs from related terms
- Severance and payment for untaken holiday – holiday compensation is remuneration and therefore subject to tax and contributions. It does not belong inside the severance. - Severance and outstanding pay claims – outstanding pay remains pay, even where it is negotiated as part of a settlement. - Severance and compensation for a restrictive covenant – compensation for a post-contract non-compete is remuneration and subject to contributions. - Severance and social plan benefit – the social plan is the collective basis; the severance is the individual payment arising from it.
6. Variants and adaptations
- Severance in a termination agreement – the most frequent case, freely negotiated. - Severance in a court settlement – in unfair dismissal proceedings, often along the rule of thumb of half a month's pay per year of service; it is not binding. - Statutory severance offer – on a redundancy dismissal, against a waiver of the claim. - Social plan severance – on operational changes, following a formula set in the social plan. - Compensation for disadvantage – where the employer carries out an operational change without a reconciliation of interests.
7. Advantages and challenges
Advantages
- Free of social security contributions — the full amount is preserved
- The one-fifth rule mitigates the tax burden of the one-off payment
- For both sides, a way of ending a dismissal dispute predictably
- Social plans create uniform, traceable standards
Challenges
- No legal entitlement – the amount depends on bargaining position and litigation risk
- The benefit of the one-fifth rule arrives through the assessment, not with the payment
- Termination agreements can trigger a waiting period for unemployment benefit
- Where the notice period is not observed, the entitlement can be suspended
- Pay components wrongly declared inside the severance lead to retrospective contribution demands
8. Best practices for implementation
Separate the components cleanly
Severance, holiday compensation and outstanding pay belong shown separately – each on its own wage type. A combined line item is an audit finding.
Choose the due date deliberately
The point of receipt determines the assessment period. That can be arranged and should be discussed.
Clarify the social security treatment in advance
For larger amounts or an unclear boundary, a ruling from the collection agency creates certainty.
Point out the consequences for unemployment benefit
The waiting period and suspension are often a bigger surprise to the person concerned than the tax.
9. Tips for employers and employees
For employers
- **Do not put holiday compensation inside the severance** – it is remuneration and subject to contributions
- **Observe the notice period in a termination agreement** – falling short of it can impair the other side's unemployment benefit
- **Use dedicated wage types** – severance is taxable and contribution-free, a combination that does not exist as standard
For employees
- **Take advice before signing** – the waiting period, suspension and tax effect decide the real value
- **Expect less net in the month of payment** – the one-fifth rule now works through the tax return
- **File a tax return** – without one the mitigation of progression goes unused
- **Do not let yourself be pressed** – a termination agreement is barely challengeable once signed
10. Conclusion
Severance is negotiated compensation, not an entitlement – and all its peculiarities follow from that single point: it is free of contributions because it pays for no work, and fully taxable because it is received. Two things are regularly underestimated in practice: that the one-fifth rule now takes effect only through the tax return, and that a termination agreement can trigger a waiting period and suspension for unemployment benefit. Both belong before the signature, not after it.
For an international group, the first sentence is the one to carry over. German law has no statutory severance entitlement outside the specific cases named above. Where a parent company budgets a redundancy on the assumption of a statutory formula, it is budgeting for something that does not exist – what does exist is a negotiation whose outcome depends on the strength of the dismissal case.
This entry does not replace advice on an individual case.
A note on sources: there is no official English version of the Dismissal Protection Act, the Income Tax Act or SGB IV; the German texts are cited below and their wording governs.
Sources
- Section 1a KSchG – Severance on a redundancy dismissal (German original; no official English version) (opens in a new tab)
- Section 24 EStG – Compensation payments (German original) (opens in a new tab)
- Section 34 EStG – Extraordinary income (the one-fifth rule; German original) (opens in a new tab)
- Section 14 SGB IV – Remuneration (German original) (opens in a new tab)
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