A settlement agreement with severance pay sounds tempting: quick money, no notice period, clean break. Yet many employees overlook the long-term consequences. The settlement agreement waiting period is one of the biggest risks — it can suspend unemployment benefits for several weeks. And the severance payment can also have unwelcome effects on citizen’s benefit (formerly Hartz IV). In this article, you will learn when a waiting period looms, how the severance payment impacts your benefits, and what you must check before signing.
Settlement Agreement with Severance Pay: What Lies Behind It?
A settlement agreement is a mutual arrangement between employer and employee to end the employment relationship. Unlike a dismissal, it requires no special form beyond written form. Often, a severance payment is made as compensation for the loss of the job. For many employees, this appears an attractive solution because they receive money faster and avoid a lengthy unfair dismissal claim. But appearances deceive: anyone who signs a settlement agreement generally waives their dismissal protection and all associated rights. That can become expensive later, especially when unemployment benefits are at stake.
Before accepting a settlement agreement, you should know the financial consequences. The severance payment is a one-off sum, but it can come with significant drawbacks — not only tax-wise, but also for social benefits. Anyone considering a settlement agreement should therefore factor in the potential waiting period. More on the basics of severance pay can be found in our guide Severance Pay after Dismissal.
When Does a Settlement Agreement Waiting Period Apply?
The Employment Agency imposes a waiting period if the employee causes their own unemployment without good cause. A settlement agreement usually counts as such a voluntary resignation because the employee actively participates in ending the employment relationship. Under Book III of the Social Code, the waiting period is typically twelve weeks. During this time, there is no entitlement to unemployment benefits. That means: you receive no payments for up to three months, even though you register as unemployed. Repeated waiting periods can extend the duration even further.
A waiting period is avoided only if the employee can prove good cause for the termination. This applies, for example, if the employer has issued a redundancy dismissal or if the settlement agreement came about at the employer’s initiative. Continued employment may also be unreasonable, for instance due to serious breaches of contract by the employer. However, you must credibly demonstrate these reasons to the Employment Agency. In case of doubt, the authority decides based on the file.
The waiting period is not the only problem: it also pushes back the start of the unemployment benefit entitlement. This shortens the total benefit period because the waiting period is credited against the entitlement duration. Anyone signing a settlement agreement should therefore realise that they not only receive no money for twelve weeks, but later also draw less unemployment benefit overall. This double burden catches many employees unprepared.
How Does the Severance Payment Affect Unemployment Benefits?
The good news: a severance payment made as compensation for the loss of the job is not offset against unemployment benefits. It does not count as income within the meaning of social law. This means you may keep the severance payment without your unemployment benefits being reduced. However, the severance payment can have indirect negative consequences if it is linked to a waiting period. During the waiting period you receive no unemployment benefits, and the severance payment must serve as a bridge.
Another point is the so-called “compensation for lost earnings”. If the severance payment is not made as compensation for the job loss but for outstanding wages, it can be offset against unemployment benefits. This is rare in practice. Usually, the severance payment is agreed as a settlement of dismissal protection claims, so it is not offset. Nevertheless, you should examine the wording in the settlement agreement carefully. If it states that the severance payment is made “offset against all claims”, this could be interpreted differently.
A common mistake is assuming that the severance payment increases unemployment benefits. That is not the case. The amount of unemployment benefits depends solely on the earnings achieved in the last twelve months. A severance payment plays no role. Anyone receiving a high severance payment should therefore not expect higher unemployment benefits. Conversely, a waiting period can lead to lower unemployment benefits because the benefit period shrinks. More on payout details can be found in our article Severance Pay Immediately Due.
Severance Payment and Citizen’s Benefit: What Counts as Income or Assets?
Unlike unemployment benefits, the severance payment is very much taken into account for citizen’s benefit (formerly Hartz IV). Citizen’s benefit is a tax-financed basic security granted only in case of need. A severance payment increases the applicant’s income and assets and can therefore reduce or even completely eliminate the entitlement to citizen’s benefit. The severance payment is counted as income in the month it is received. If it is not spent immediately, it is treated as assets and can end the entitlement to citizen’s benefit for several months.
There are, however, exempt amounts. Under citizen’s benefit law, certain asset allowances apply, varying according to personal situation. For example, a basic allowance of €10,000 for single persons and further allowances for necessary purchases are provided. If your severance payment exceeds these allowances, you must first deplete your assets before receiving citizen’s benefit. This can mean going without benefits for a long time, even though you are unemployed.
It is therefore important not to spend the severance payment hastily, but to calculate its impact on citizen’s benefit. If you already receive citizen’s benefit and obtain a severance payment, you must notify the authority immediately. Otherwise, reclaims and even sanctions may follow. The authority examines whether the severance payment is treated as income or assets. In practice, the severance payment is sometimes spread over several months to smooth the offsetting. This is, however, only possible in exceptional cases and requires a corresponding agreement with the job centre.
Avoiding a Waiting Period: What Employees Should Watch for Before Signing
The good news: a waiting period can often be avoided if you structure the settlement agreement skilfully. The key point is that the agreement must not be classified as a “voluntary resignation”. To avoid a settlement agreement waiting period, you should draft the contract so that the termination occurs at the employer’s initiative. This can include a clause stating that the employer wishes to end the employment for operational reasons. Stating a good cause, such as an impending redundancy dismissal, can also prevent the waiting period.
Another approach is agreeing a “run-out period”. This means the employment relationship ends only after a certain period during which you continue to receive your salary. In this time you can register as a jobseeker, and the Employment Agency cannot impose a waiting period because the employment relationship still exists. However, you must actually observe the run-out period. If you leave earlier, the waiting period applies again.
Moreover, you should not view the severance amount merely as a bargaining chip, but also plan for the tax and social-law consequences. An excessively high severance payment can mean you receive no benefits, while one that is too low does not compensate for the waiting period. A rule of thumb suggests the severance payment should be at least half a year’s salary to offset the disadvantages of the waiting period. This is only a rough guide, not a guarantee. If you wish to avoid a settlement agreement, you can also wait for the employer to dismiss you and then file an unfair dismissal claim. Information on this is available in our guide Unfair Dismissal Claim: Everything You Need to Know.
Have the Settlement Agreement Reviewed: When a Specialist Lawyer Pays Off
A settlement agreement is not a signature to be given lightly. The legal and financial consequences are complex and can easily lead to disadvantages. We therefore strongly recommend having the contract reviewed by an independent specialist lawyer for employment law before signing. The lawyer can not only assess the severance amount but also identify clauses that could trigger a waiting period. They can also negotiate and adapt the contract in your favour.
The costs for a lawyer are usually well invested, because a wrong decision can quickly cost several thousand euros. If you cannot afford the fees, options such as legal aid or advisory assistance exist. In addition, you can engage a litigation funder like RechtStark, which covers the costs of a potential lawsuit if you wish to challenge the dismissal. RechtStark examines your risk and finances the proceedings if there are prospects of success. This allows you to defend your rights without financial risk.
A specialist lawyer can also clarify whether an unfair dismissal claim is more sensible than a settlement agreement. In many cases, it is better to challenge the dismissal and reach a settlement before the labour court. A settlement has the advantage that the waiting period is avoided because the termination is not based on your will. Moreover, you can often negotiate a higher severance payment, as the employer fears the risk of litigation. The lawyer knows the usual settlement figures and can advise you accordingly.
Conclusion: Severance Payment Yes, But Not Without Weighing the Consequences
A settlement agreement with severance payment can be a sensible solution if you know the risks and assess them correctly. The settlement agreement waiting period is the biggest obstacle, as it can put a serious strain on your financial situation. The effects on citizen’s benefit should not be underestimated either. However, if you have the contract carefully reviewed and pay attention to skilful wording, you can minimise the drawbacks. Seek advice from a specialist lawyer in case of doubt and weigh up whether an unfair dismissal claim is the better alternative. Only then can you ensure you do not end up with less in your pocket than you expected.
Note: This article is for general information purposes only and does not replace individual legal advice. For a free initial assessment of whether litigation funding may be an option for your case, you can contact RechtStark.