Receiving Severance Pay Tax-Free: Your Options as an Employee
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.
After years of working together, companies often part ways with their employees for various reasons. Severance pay (Abfindung) is not unusual for employees – a bonus on top of their regular salary. In this article, we explain how to declare severance pay correctly and pay less tax through planned investments. Please note that this article never replaces individual tax advice.
With the know-how and experience of Neo Capital GmbH, you can be confident that your investment decisions are optimally coordinated from a tax perspective, so that you keep as much of your severance pay as possible. Take the opportunity to invest your severance pay optimally and get non-binding advice from one of our experts.
How severance pay from employment is taxed
Under German tax law, severance pay is extraordinary income that is taxable under Section 34 of the German Income Tax Act (EStG) – neither the amount of the severance payment nor the length of employment exempts it from income tax, and since 2006 tax-free allowances no longer apply to severance payments. Two models nevertheless help to cushion this income for tax purposes: the classic one-fifth rule (Fünftelregelung) and investments that reduce the tax burden on the severance pay – such as a photovoltaic direct investment. Under the one-fifth rule, one fifth of the severance payment is notionally added to your income, the resulting tax burden is compared, and five times the difference is assessed as the tax payable. This model is particularly worthwhile for employees with as little other income as possible and as high a severance payment as possible in the same year.
Investing in long-term assets: the alternative for your taxes
Such a structure can be achieved more simply and in a more future-proof way via the Investitionsabzugsbetrag (IAB, investment deduction), which covers various eligible business assets. Compared with the one-fifth rule – where the solidarity surcharge and any church tax further increase the tax burden – a photovoltaic investment stands out because the expenditure reduces the profit from the severance pay. Compared with real estate and other asset classes, up to 62% of the acquisition costs can already be taken into account for tax purposes in the year of acquisition. In this way, employees receiving severance pay reduce their taxable income and invest sustainably in solar energy while their private wealth grows.
Saving tax by paying into retirement provision
Employees can pay their severance pay in instalments into their existing retirement provision – payments into direct insurance (Direktversicherung), pension funds (Pensionskassen) or Pensionsfonds additionally reduce the tax burden. The maximum amount is 4% of the contribution assessment ceiling (Beitragsbemessungsgrenze) of the statutory pension insurance, multiplied by the number of years of employment (upper limit: 10 years). Example: with nine years of service and a contribution assessment ceiling (West) of €85,200 in 2023, this gives €85,200 × 4% × 9 years = €30,672, which can flow tax-free into retirement provision. With a Rürup pension, contributions in 2023 are also already 100% deductible as pension expenses (Section 10(1) No. 2 and Section 10(3) EStG) – the maximum for deductible special expenses in 2023 was €26,528 (individual assessment) or €53,056 (joint assessment).
Neo Capital GmbH: your partner for tax reduction through investments
Investing severance pay in a photovoltaic investment is an attractive way to pay less tax in the year of acquisition. As an alternative to the one-fifth rule, we advise our clients individually on severance pay they have received or are about to receive, working hand in hand with your tax adviser. Are you expecting severance pay or have you already received extraordinary income? We will be happy to advise you individually and free of charge on optimising your tax burden.
Frequently asked questions
Is a direct investment in photovoltaics better than applying the one-fifth rule?
Compared with standard taxation and the one-fifth rule, a photovoltaic investment is one way to approach the use of your severance pay in a tax-optimised manner. Every situation is individual and depends on the amount of the severance pay, your tax rate and other factors.
Is severance pay taxed like my salary?
Under Section 34 EStG, severance payments are extraordinary income that is generally subject to standard taxation. Using individually selected measures, we create an Investitionsabzugsbetrag (IAB, investment deduction) for our clients to reduce the tax burden on the severance pay – for example through a photovoltaic direct investment.
Is severance pay always taxed in the same way?
Receiving severance pay gives rise to taxes, which can be calculated using the one-fifth rule, among other methods. Alternatively, investments can be made that reduce the tax burden. Feel free to ask us about these measures – we will advise you comprehensively and without obligation.