Taxes · 3 min read

The one-fifth rule for severance pay: how income from severance payments can be taxed

This guide refers to German law and the German tax system. It is a translation of our German original and does not replace individual tax or legal advice.

Anyone who receives severance pay (Abfindung) from their employer, for whatever reason, has to take it into account for tax purposes. German law offers you several options for this, and alongside standard taxation the best known is the one-fifth rule (Fünftelregelung). We introduce this tax instrument for your income and explain which alternatives are available to you as an employee when you receive severance pay. At no point does our insight into the world of tax structuring replace advice from a tax adviser.

Neo Capital GmbH supports employees who receive severance pay in investing this income in a tax-optimised way. As independent advisers, we rely, among other things, on IAB investments in order to convert our clients' tax burden into private wealth over the long term. Our advice is tailored individually to the needs and situation of our clients, which promises the maximum tax saving compared with applying the one-fifth rule to your severance pay. Get independent advice on our pre-tax IAB investments and benefit from many years of experience in this field.

Calculating the tax on your severance pay with the one-fifth rule

Since 2006, severance payments in Germany have been subject to income tax in full, which leads to a higher tax burden for employees. Because of tax progression, this is particularly evident in the amount of the severance payment, which is added to normal income. To soften this effect, the legislator created the one-fifth rule as a new tax instrument, and its calculation always works the same way: one fifth of the severance payment is added to the regular taxable income. The income tax due on this is compared with the tax burden without the severance payment, which results in a difference. Five times this difference is then assessed as the income tax on the severance payment. Leaving aside an investment of the severance payment for the moment, the one-fifth rule is particularly worthwhile for employees with a low income and a high severance payment. Here the difference from regular income is greatest and the tax burden falls most in relative terms. For many employers, however, investing the severance payment at its gross amount is the more suitable option. Under German social security law, severance payments on dismissal are not regarded as employment income and are therefore exempt from contributions without any limit on the amount.

The alternative to the one-fifth rule: IAB investments as a tax saving

As an employee receiving severance pay, you have two options. With the first option, you make use of the one-fifth rule and benefit slightly compared with standard taxation of your income. What remains is taxed capital that you can use for investing. We have focused our advice on the second option and would therefore like to show you an investment opportunity that gives you significantly more investment volume before tax. This involves investments in business assets that qualify for the Investitionsabzugsbetrag (IAB, investment deduction). Using a photovoltaic system as an example, the tax burden on your severance payment can be reduced to zero by setting investment expenditure against it. Over the long term, purchasing a PV system converts the former tax burden on your severance payment into private wealth. You therefore keep 100% of the investment sum, invested sustainably in solar investments. The second advantage is the source of income lasting decades that you create with a solar installation. In addition to the PV system you have purchased and deducted alongside the severance payment, you achieve a return of around 7% through electricity generation. This tax structuring model therefore enables you to use your severance pay with maximum efficiency.

Neo Capital GmbH: independent investment advice for your severance pay

As advisers for tax-optimised investments, our experience is that clients who receive comprehensive support achieve the best results. That is why we support you from the very first minute in investing wealth from severance payments sustainably and with low risk. Unlike with the one-fifth rule, we avoid tax that would otherwise have to be paid because no investment decisions were made. To do this, we rely on IAB-qualifying business assets such as PV systems. With ongoing income and a shift from tax burden to private wealth, you can be sure that you are getting the most out of your severance pay. Would you like to talk to one of our experts about your severance pay? Let us take a look at your individual situation and determine how much tax a PV investment can save you. It does not matter whether you are expecting your severance pay or have already received it. Together we take a close look at your starting position and advise you independently on your options. If you wish, we work hand in hand with your tax adviser. So make the most of your income and secure your no-obligation consultation with us.