Reviewing a Settlement Agreement: Why Severance Pay Is Not the Only Issue

Severance pay is a one-off payment. It can compensate for the loss of employment and provide financial security.

However, a higher severance payment may be less valuable than it first appears if the employee leaves the employment relationship much earlier in return.

A later termination date can mean that the employee continues to receive salary for several months, remains covered by social security and has more time to find a new job.

For this reason, an offer should not be assessed only by looking at the gross severance amount.

An employee earns EUR 5,000 gross per month.

The employer offers two options:

Option A: The employment relationship ends in one month. The employee receives severance pay of EUR 20,000.

Option B: The employment relationship ends only in four months. Until then, the employee is released from work duties with continued salary payments and also receives severance pay of EUR 10,000.

At first glance, Option A seems better because the severance payment is higher.

On closer inspection, however, Option B may be financially more attractive. The employee receives three additional monthly salaries, remains covered by social security for longer and has more time to find a new job.

This example shows: the highest severance payment is not automatically the best offer.

A later termination date often means that the employee continues to receive salary until the end of the employment relationship.

This can be financially very valuable. Three additional monthly salaries may be worth more than a slightly higher severance payment.

In addition, further claims may arise or remain during this period, for example in connection with special payments, company pension schemes or variable remuneration. Whether such claims exist depends on the employment contract and the relevant rules.

As long as the employment relationship continues and salary is paid, social security coverage generally continues as well.

This concerns in particular:

• health insurance,

• long-term care insurance,

• pension insurance,

• unemployment insurance.

This can be a significant advantage for employees. After the end of the employment relationship, it must be checked how health insurance coverage is secured, especially if unemployment benefits are not paid immediately or if the claim is suspended.

A later termination date can give the employee more time to find new employment.

This is particularly important if no new job has been secured yet.

If the employee is released from work duties during the remaining term, they may be able to focus more easily on applications and interviews. At the same time, they remain employed until the termination date and continue to receive salary.

A later termination date can also be important in connection with unemployment benefits.

If the employment relationship ends before the applicable notice period has expired and the employee receives severance pay, unemployment benefits may be suspended because of the severance payment.

If the notice period is observed, this risk is generally lower.

Independently of this, a settlement agreement may still lead to an examination of a blocking period. The termination date, notice period and reason for termination should therefore always be assessed together.

More on severance pay and suspended unemployment benefits

More on settlement agreements and blocking periods

For employees with a residence permit, the termination date can have additional importance.

If the right to stay in Germany is linked to employment or to a specific employer, the end of the employment relationship can have practical and legal consequences.

A later termination date can then be valuable because it provides more time to:

• find a new job,

• prepare a change of employer,

• collect documents for authorities,

• clarify residence-related questions,

• and organize the transition to new employment.

Important: residence law depends heavily on the specific residence permit. Expats should therefore have checked whether and how a settlement agreement may affect their residence status or a change of employer.

If a later termination date is agreed, release from work duties is often also regulated.

This means that the employee no longer has to work but continues to receive salary until the end of the employment relationship.

It is important whether the release is revocable or irrevocable.

In the case of revocable release, the employer may generally require the employee to return to work. This can make planning more difficult.

In the case of irrevocable release, it is clearer that the employee no longer has to work until the end. This can be advantageous for job search and personal planning.

In the case of release from work duties, vacation, overtime and other income should be clearly regulated.

The following questions are particularly important:

• Is unused vacation consumed during the release period?

• Are overtime hours compensated or offset by the release?

• May the employee take up a new job during the release period?

• Is income from a new job offset against the continued salary?

• Does the non-compete obligation continue until the end of the employment relationship?

These points should not be left open. Unclear provisions may later lead to disputes or change the economic value of the offer.

A later termination date is not automatically better in every case.

It can also have disadvantages.

The employee remains bound by the employment relationship for longer. This may be problematic if they want to start a new job quickly.

In addition, a non-compete obligation may continue to apply during the ongoing employment relationship. This can make it more difficult to take up a new job if it is with a competitor.

From a tax perspective, the comparison between salary and severance pay can also be complex. Ongoing salary is taxed regularly. Genuine severance pay may be tax-privileged under certain conditions. Which option is better after tax depends on the individual case.

More on the taxation of severance payments

If a dismissal has already been issued, filing an unfair dismissal claim can be an important way to protect the employee’s negotiating position.

If no claim is filed in time, the dismissal may generally be deemed effective after the claim period has expired. The employee may then lose important leverage in negotiations.

Filing a claim does not necessarily mean that the employee must litigate until the end. In many cases, it is also about having the dismissal reviewed and achieving a better settlement.

Negotiations do not have to focus only on severance pay. The termination date, release from work duties, reference letter, vacation, bonuses or other outstanding claims may also become part of a settlement.

A separation agreement after dismissal should also not be assessed only by looking at the severance payment.

Such an agreement is typically concluded after a dismissal has already been issued. It regulates the consequences of the dismissal, such as severance pay, release from work duties, reference letter or waiver of claims.

The waiver of an unfair dismissal claim can be particularly important. If the employee waives the right to file a claim, they may lose their negotiating position. Before signing, it should therefore be checked whether the dismissal is challengeable and whether the offer economically justifies the waiver.

More on settlement agreements after dismissal

Before signing a settlement agreement or separation agreement, employees should not only check the severance amount.

The following questions are particularly important:

1. Is the severance payment really financially better than a later termination date?

2. How much salary would still be paid until a later termination date?

3. Is the ordinary notice period observed?

4. Is there a risk of a blocking period for unemployment benefits?

5. Could unemployment benefits be suspended because of severance pay and a shortened notice period?

6. Does social security coverage continue until the end?

7. Is the release from work duties revocable or irrevocable?

8. Are vacation and overtime consumed or paid out?

9. May a new job be taken up during the release period?

10. Is income from a new job offset?

11. Are there outstanding claims for bonuses, commissions or variable remuneration?

12. Are there special issues because of a residence permit or change of employer?

13. Is the reference letter regulated?

14. Is a waiver of claims included?

In a settlement agreement or separation agreement, severance pay is important. But it is not the only decisive point.

A later termination date may be financially more valuable than a higher one-off payment. It can provide continued salary payments, social security coverage, more time to find a new job and better financial bridging.

At the same time, a later termination date can also have disadvantages, for example because of longer contractual ties, non-compete obligations or unclear release provisions.

The overall package should therefore always be reviewed: severance pay, termination date, release from work duties, vacation, outstanding remuneration, unemployment benefits, social security, tax consequences and, for expats, possible residence-related issues.