Severance pay tax in Germany: how the one-fifth rule (Fünftelregelung) works — with a worked example

Severance pay: no social security, but the tax office is waiting

A genuine severance payment is compensation for the loss of the job, not remuneration for work performed. For that reason it is free of contributions to health, pension, long-term care and unemployment insurance — for employees with compulsory insurance there are simply no social deductions. Exceptions exist in special constellations, for instance for people who are voluntarily insured in the statutory health system, where a severance payment can partly count towards their contribution base.

The tax side looks entirely different. A severance payment is employment income and is taxable in full — in the year of payment. Without any correction the whole amount would be stacked on top of the annual income and land in the highest “floors” of the progressive scale, as if the employee had suddenly earned tens of thousands of euros more. That is exactly what the one-fifth rule is there to prevent.

How the one-fifth rule works

The rule in section 34 (1) EStG rests on a simple fiction: the tax on the severance payment is calculated as if the money arrived over five years, one fifth per year. The calculation takes three steps:

• Step 1: calculate the income tax on the annual income without the severance payment.
• Step 2: calculate the tax on that income plus one fifth of the severance payment and take the difference to step 1.
• Step 3: multiply the difference by five — the result is the tax on the entire severance payment.

The benefit comes from the fact that one fifth of the payment climbs only one small floor of the progression curve instead of five. The steeper the rate rises in the bracket the payment falls into, the more the rule saves.

Worked example: a severance payment of 20,000 euros

Marek (a fictitious example) spent well over a decade working in a production plant in Hesse. His employer closes the department and offers a termination agreement: employment ends with the year, plus a severance payment of 20,000 euros gross, paid out together with the final salary. Marek’s taxable income for the whole year — after deductions, without the severance — is 45,000 euros. He is assessed individually and pays no church tax.

Under the 2026 tax scale the calculation runs as follows:

• Step 1: tax on 45,000 euros = 8,835 euros.
• Step 2: one fifth of the severance is 4,000 euros. Tax on 49,000 euros = 10,198 euros. Difference: 1,363 euros.
• Step 3: 1,363 euros × 5 = 6,815 euros of tax on the whole severance payment.

Compare that with the calculation without the relief: the tax on 65,000 euros is 16,205 euros, so 16,205 − 8,835 = 7,370 euros would fall on the severance. The one-fifth rule saves 555 euros.

Surprised it is so little? That is a very common outcome. In the middle zone of the German scale — roughly between 17,800 and 69,900 euros of taxable income — the marginal rate rises gently, so flattening the progression with one fifth has a limited effect. The rule is not broken, its power simply depends on the configuration of income and payment.

When the rule saves serious money

Two scenarios change the picture fundamentally. First: a high severance payment. A manager with a taxable income of 40,000 euros who receives 90,000 euros after twenty years of service pays 31,295 euros of tax on the severance with the one-fifth rule instead of 36,255 euros — a saving of almost 5,000 euros. Without the relief a large part of the payment would fall straight into the 42 percent zone.

Second: low remaining income in the year of payment. If one fifth of the severance lands in the lower zones of the scale — in the extreme case below the basic allowance of 12,348 euros — the tax on the severance can drop very low, even to zero. So if the separation falls late in the year and the following year promises lower income, it is worth negotiating in the termination agreement that the severance becomes due in January of the following year. One caveat: unemployment benefit is itself tax-free but raises the rate applied to the rest of the income (Progressionsvorbehalt) — that has to be factored in individually.

Three conditions without which the relief is lost

• The payment must be compensation for losing the job. The relief covers compensation within the meaning of section 24 no. 1 EStG (in conjunction with section 34 (2) no. 2 EStG) — the typical severance from a termination agreement, court settlement, social plan or section 1a of the Dismissal Protection Act (KSchG). Outstanding wages, bonuses or allowances settled “on the occasion” of the exit are ordinary pay and generally do not qualify. The agreement should separate these items clearly.
• The income must bunch up (Zusammenballung). Together with the severance the employee must receive more in the year than they would have earned had the employment simply continued. With a seamless move to a new job plus a severance payment the condition is usually met. Doubts arise where the payment is small and a long gap in income follows — that needs to be calculated before the year ends.
• Payment within one tax year. Splitting the severance into instalments over two years destroys the relief entirely — for both parts. Tax administration practice tolerates only a minor partial payment, as a rule of thumb up to about 10 percent of the main amount.

Since 2025: full withholding first, relief only via the tax return

Until the end of 2024 employers applied the one-fifth rule directly in payroll — the employee received the severance with a lower deduction straight away. The Growth Opportunities Act (Wachstumschancengesetz) abolished that duty. Since January 2025 the employer withholds wage tax on the full amount like on any one-off payment and merely reports the severance separately in the annual wage tax certificate (Lohnsteuerbescheinigung).

The relief itself has not disappeared — it is now applied by the tax office in the annual assessment. The practical consequence is twofold. First, the net amount arriving in the month of payment is noticeably lower than many employees expect, and the overpayment only comes back after the tax return is filed. Second, without a tax return the relief is lost in practice — nobody applies it automatically. Anyone who receives a severance payment should treat the tax return for the year of payment as a fixed item on the agenda, even if they have never filed one before.

What this means when you negotiate your exit

• Name the payment correctly. In the termination agreement the severance should be described as compensation for the loss of the job (customarily with reference to sections 9 and 10 KSchG) and kept separate from outstanding wages, bonuses or allowances.
• One amount, one date. Agree on payment in full within a single tax year and choose that year consciously — the current or the following one.
• Plan your liquidity. Since 2025 the net amount in the month of payment is clearly lower than the final result after the refund from the tax office.
• Tax is not everything. A termination agreement can cost far more on the unemployment-benefit side (waiting period, the so-called Sperrzeit) than it gains on tax — these consequences should be assessed before signing, ideally with a lawyer. We cover neighbouring questions in our articles on dismissal under workforce pressure and proceedings before the German labour court.
• Collect the documents for the return: the termination agreement or settlement, the wage tax certificate with the severance shown separately, proof of receipt.

Frequently asked questions

Do I pay social security contributions on severance pay in Germany?
No. A genuine severance payment for the loss of the job is not remuneration for work and, for employees with compulsory insurance, is free of health, pension, long-term care and unemployment insurance contributions. Special constellations can differ, for example for people voluntarily insured in the statutory health system.

Will my employer apply the one-fifth rule at payout?
Since 2025 no. The employer withholds wage tax on the full amount, and the one-fifth rule is applied only by the tax office in the annual assessment. The precondition is filing a tax return for the year in which the severance arrived.

What happens if the severance is paid in instalments over two years?
As a rule the relief is lost for the entire payment, because the required bunching of income within one year is missing. Tax administration practice accepts only a minor partial payment of up to roughly 10 percent of the main amount. When negotiating the exit, insist on one amount and one date.

Does the one-fifth rule always bring a large saving?
No. With an average income and a severance payment of around 20,000 euros the benefit is often just a few hundred euros, because the progression rises gently in the middle zone of the scale. Large savings occur with high severance payments and where the remaining income in the year of payment is low.

Does a severance payment reduce unemployment benefit?
The severance itself is not offset against ALG I. The risks lie elsewhere: if the employment ends without observing the notice period, the benefit can temporarily rest, and a termination agreement concluded without good cause can trigger a waiting period (Sperrzeit) of up to 12 weeks. These consequences should be assessed before signing.

Calculations based on the income tax scale of section 32a EStG as in force for the 2026 assessment year (basic allowance 12,348 euros), single assessment, excluding church tax and solidarity surcharge, amounts rounded to full euros. Legal bases: section 34 (1) and (2) EStG, section 24 no. 1 EStG and the withholding changes in force since 1 January 2025 (Growth Opportunities Act). The examples are fictitious. This article is for general information and does not replace legal or tax advice in an individual case.

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