One-fifth rule for severance pay in Germany

Severance payments in Germany are fully taxable, and because they are often paid in a single lump sum, they can push employees into a much higher tax bracket. The one-fifth rule (Fünftelregelung) is a special tax mechanism that reduces this burden by spreading the tax calculation over five parts, even though the money is paid in one year. This article explains when the rules apply, how they changed in 2025, and what alternatives exist if to using the one-fifth rule in Germany.

Key takeaways:

• Severance pay is treated as taxable income and can push employees into a higher tax bracket.
• The one-fifth rule grants a tax reduction, but only if the payment counts as compensation and is largely paid in one tax year.
• Until 2024, the rule is applied automatically via payroll. From 2025 on, employees must claim it in their tax return.
• The rule is helpful, but not always the best option; in some cases, shifting the payout to a low-income year saves more tax.

Why severance pay leads to high taxes

A severance payment (Abfindung) is classified as “extraordinary income” under German tax law. Because German income tax is progressive, adding a large, one-time payment on top of normal salary can move the employee into a much higher marginal tax bracket. In extreme cases, almost half of the severance ends up with the tax office.

The one-fifth rule exists to prevent this stacking effect. Instead of taxing the entire severance at once, the tax rate is calculated as if the payment had been spread across five years – even though it is paid immediately.

Conditions for using the one-fifth rule

The tax office applies the rule only if all of the following conditions are met:

• Compensation character: The payment must replace future income (§ 24 No. 1 EStG).
• Mostly one-year payout: At least 90 % of the total must be paid in the same tax year. Small residual payments (max. 10 %) may fall into the following year.
• Income bunching: The total income in the payout year must exceed the amount that would have been earned without termination.
• No disguised instalments: Artificial splitting across multiple years disqualifies the relief.

Example: How the one-fifth rule is calculated

The tax saving does not reduce the severance itself – it reduces the tax rate applied to it. The calculation always follows four steps – like in this example: 

A single employee earns €40,000 in 2023 and receives a €60,000 severance.

1. Tax on €40,000 salary: €8,452
2. Tax on €40,000 + €12,000 (one fifth of severance): €12,930
3. Delta : €4,477
4. Delta x 5: €22,385 tax on the full severance

Without the rule, the entire €60,000 would be taxed at a much higher marginal rate, resulting in a larger tax bill.

Tax tipp: timing the payout can still be smarter

If you know you will have little or no taxable income in the following year (e.g. unemployment, retirement, sabbatical), it can be cheaper to shift the payment instead of using the one-fifth rule. A lower overall income automatically lowers the tax rate, even without special rules. However, splitting the payment may temporarily trigger higher wage tax (tax class VI), so it is vital to run the numbers first.

How the rule is applied: payroll vs. tax return

• Until 2024: Employers must apply the one-fifth rule automatically in payroll, as long as it benefits the employee. You can verify this on your payslip.
• From 2025 onward: The “Wachstumschancengesetz” removes the rule from payroll entirely. Employees must claim it themselves in their tax return. If they forget, the full tax applies – no automatic correction.

Why the 2025 change matters for employers

In the past, tax auditors sometimes ruled that the conditions for the rule were not met, forcing employers to pay back wage tax (Lohnsteuerhaftung). The 2025 reform shifts responsibility to employees and removes this risk for companies.

Other ways to reduce tax on severance

• Delaying the payout into a year with lower income
• Combining severance with a sabbatical or early retirement
• Using deductible pension contributions to reduce taxable income
• Timing termination to avoid overlap with bonus or vacation payouts

Frequently asked questions (FAQ)