Although executive severance pitfalls often turn a seemingly generous payout into a disappointing net amount, leaders must look beyond the headline figure when negotiating a severance package.
The €700,000 figure mentioned in recent news is a prominent example of how misleading raw numbers can be. If you are a leader facing dismissal or a settlement agreement, you need to consider not only the headline payment but also tax, social‑security and employment‑law specifics that often do not apply to regular employees in the same way. These considerations form the basis for the pitfalls examined in detail below.
Executive Severance Pitfalls: What Leaders Need to Know
Who Qualifies as a Leading Employee Under Labor Law?
Not every manager with “Manager” on the business card is automatically a leading employee in the sense of the Works Constitution Act. The decisive factor is § 5 BetrVG: leading employees are workers who, due to their employment contract and position in the company, are entitled to hire and dismiss other employees independently or hold a general power of attorney/prokura. Also, anyone who regularly makes substantial decisions that significantly shape the business may qualify. The distinction is often disputed in individual cases and is examined strictly by courts. Those who meet the criteria lose important protective mechanisms — such as access to the works council and thus co‑determination in individual personnel measures. This classification is the first step to recognizing the later pitfalls.
No Special Dismissal Protection and No Social Selection: The Weaker Legal Position
The main difference: for leading employees the general dismissal protection under the Dismissal Protection Act does not apply if the company has more than ten employees. While the General Equal Treatment Act (AGG) protects against discriminatory dismissals, the social selection under § 1 KSchG — i.e., weighing age, length of service, maintenance obligations and severe disability — does not apply. The employer does not have to conduct a social selection among leading employees in case of business‑related dismissals. Consequently, a 55‑year‑old department head with 20 years of service and two children can be dismissed more easily than a 30‑year‑old colleague without family obligations, provided the dismissal is not arbitrary or discriminatory. This legal situation greatly strengthens the employer’s negotiating position. For more details see § 14 KSchG, which excludes leading employees from the scope of the Dismissal Protection Act.
The €700,000 Trap: Tax Progression, Limits of the Fifth Rule and Solidarity Surcharge
These executive severance pitfalls illustrate why the gross figure can be misleading. A severance of €700,000 gross sounds like lifelong security. The reality is different: severance payments are fully taxable. Although the fifth rule (§ 34 EStG) mitigates progression by spreading the amount over five years fictitiously, the effect is insufficient at this level to avoid the top tax rate of 42 % (plus solidarity surcharge). For example, a single taxpayer in western Germany with a taxable income including the severance of €700,000 quickly faces an effective tax burden of over 45 % — i.e., more than €300,000 paid to the tax office. The solidarity surcharge is added on top. Moreover, the fifth rule only applies if the payment is labeled as “compensation for lost earnings” and not as a salary component (e.g., a bonus). Wording mistakes in the termination agreement can destroy the tax advantage entirely. Those unaware of these tax pitfalls end up paying considerably more than necessary.
Blocking Period in Termination Agreements: Why Leaders Are More Often Affected
Many leaders opt for a termination agreement to secure a “clean” exit. However, the Federal Employment Agency usually imposes a twelve‑week blocking period for unemployment benefit I when the employee initiates the separation (§ 159 SGB III). The suspension of the claim means: no payments, but also no pension insurance contributions during that time. For leaders the risk is higher because they often earned higher salaries and therefore paid higher contributions — losing these contributions hurts the future pension more. In addition, the agency scrutinizes carefully whether there was an “important reason” for giving up the job. A mere “offer from the employer” is not enough. Those who sign without preparation lose not only money but also insurance periods. A look at Negotiating severance in a large corporation shows how important strategic preparation is, especially with high salaries.
Social Security: Severance Is Contribution‑Free — But What Does That Mean for Pension Claims and Health Insurance?
A common misconception is: “Severance is free of social‑security contributions, so everything is fine.” Correctly, no contributions to pension, health, long‑term care or unemployment insurance are deducted from the severance amount. However, missing contributions mean missing pension points in the statutory pension insurance. Someone who receives a large severance instead of salary in the years just before retirement forgoes pension entitlements. Regarding health insurance, in the statutory system the compulsory coverage remains if the claim to unemployment benefit I is suspended — but without contribution payments from employment income. In private health insurance the loss of the employer’s subsidy can become expensive. Anyone nearing retirement should have the pension gap caused by a severance calculated precisely.
Negotiation Levers for Leaders: Non‑Compete, Garden Leave, Outplacement and Pension Top‑Ups
Because the legal position is weaker, leaders must rely on economic levers. A post‑contractual non‑compete clause (§§ 74 ff. HGB) obliges the employer to pay a compensation of at least 50 % of the last contractual salary — often a strong lever to increase the severance. Garden leave with continued salary (possibly offset against the notice period) gains time for job search. Outplacement consulting from external providers frequently costs the employer less than a higher severance, yet it greatly supports re‑entry into the labor market. Promises to continue the occupational pension scheme (bAV) or to make a lump‑sum payment into a direct insurance can be tax‑advantaged and close the provision gap. Important: every promise must be in writing, clearly formulated and legally enforceable — verbal assurances are worthless in a dispute.
Checklist: What Leaders Should Have Reviewed Before Signing
- Status check: Are you really a leading employee under § 5 BetrVG? (impact on dismissal protection, works‑council rights)
- Tax forecast: Have the net severance calculated after the fifth rule, solidarity surcharge and church tax — not just the gross amount.
- Blocking‑period risk: Check with an employment lawyer whether the termination agreement can credibly state an “important reason” for leaving the job (e.g., an impending business‑related dismissal that would be socially justified).
- Pension gap: Calculate the missing pension points and assess compensatory payments into the occupational pension scheme or private provision.
- Health insurance: Clarify whether the employer’s contribution continues (statutory or private) during the blocking period and thereafter.
- Non‑compete: Is such a clause in place? Can it be lifted or shortened against compensation?
- Garden leave & outplacement: Negotiate paid garden leave and professional placement assistance.
- Formulations: Watch for “finality” clauses, waiver clauses and tax wording (“compensation” vs. “salary”).
- Financing: Check whether litigation funding (e.g., via RechtStark) makes sense for a dismissal‑protection lawsuit — even though leading employees sue less often, the mere threat can improve your bargaining position
Being aware of these executive severance pitfalls helps you negotiate better terms and avoid unpleasant surprises from the tax office, pension statement or employment agency. Let yourself be accompanied by an independent lawyer specializing in employment law before you sign. The investment in a legal review usually pays off, because it spots and defuses the typical pitfalls early.
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.