How to Calculate Severance Pay and Save on Taxes — Complete Guide to Interim Settlement and IRP 2026

Key Takeaways

• Severance pay = average daily wage × 30 days × years of service
• Receiving severance pay through an IRP account can defer retirement income tax payments for up to 10 years
• The service-year deduction significantly lowers the effective tax rate for long-term employees

What Is Severance Pay and How Is It Calculated?

Severance pay is a statutory benefit paid by an employer to an employee who leaves after working for at least one year. Under the Employee Retirement Benefit Security Act, all workplaces with five or more regular employees are required to pay severance benefits. Since 2022, the same severance pay obligation has also applied to workplaces with fewer than five employees.

Basic severance pay formula: Severance pay = (average wage for the three months before retirement) × (30 / number of days in those three months) × years of service

More precisely: Severance pay = (total wages for the most recent three months) ÷ (number of days in those three months) × 30 days × years of service

Practical example:

• 10 years of service, total salary for the three months before retirement: KRW 15 million (KRW 5 million per month)
• Number of days in the three-month period: 92 days (30+31+31 days)
• Average daily wage: KRW 15 million ÷ 92 days = KRW 163,043
• Severance pay = KRW 163,043 × 30 days × 10 years = KRW 48.91 million

If the calculation feels complicated, you can use the severance pay calculator and enter only your employment period and salary to calculate it automatically.

Retirement Income Tax Calculation — Benefits for Long-Term Employees

Severance pay is subject to retirement income tax. Unlike ordinary wage and salary income tax, retirement income tax has a deduction structure that favors long-term employees.

Three steps for calculating retirement income tax:

Step 1: Apply the service-year deduction

• Up to 5 years: KRW 1 million/year
• 5-10 years: KRW 2 million/year
• 10-20 years: KRW 2.5 million/year
• Over 20 years: KRW 3 million/year

Step 2: Calculate converted salary Converted salary = (retirement income − service-year deduction) × 12 ÷ years of service

Step 3: Apply the tax rate after the converted salary deduction Converted salary of KRW 8 million or less: fully deducted KRW 8 million-KRW 70 million: 60% deduction KRW 70 million-KRW 120 million: 55% deduction Over KRW 120 million: 45% deduction

Retirement income tax based on 10 years of service and KRW 48.91 million in severance pay:

• Service-year deduction: KRW 2 million × 10 years = KRW 20 million
• Retirement income after deduction: KRW 48.91 million − KRW 20 million = KRW 28.91 million
• Converted salary: KRW 28.91 million × 12 ÷ 10 = KRW 34.69 million
• Converted salary deduction (60%): KRW 34.69 million × 60% = KRW 20.81 million
• Tax base: KRW 34.69 million − KRW 20.81 million = KRW 13.88 million
• Apply the 15% tax rate: KRW 13.88 million × 15% − KRW 1.08 million = KRW 1 million (effective tax rate of about 2%)

Compared with receiving the same KRW 48.91 million as ordinary employment income, which would result in more than KRW 7 million in tax, the benefit of retirement income tax is substantial.

Deferring Retirement Income Tax with an IRP Account

If you deposit the full severance pay amount into an Individual Retirement Pension (IRP) account, you do not have to pay retirement income tax immediately and can defer it for up to 10 years or longer.

Three main benefits of using an IRP:

1. 1Tax deferral: Pay tax when you actually withdraw the money instead of paying immediately at retirement (securing an investment period for the funds)
2. 2Additional tax credit: Up to KRW 1.485 million in tax credits when contributing up to KRW 9 million per year separately from severance pay
3. 3Pension payments after age 55: Receive the funds as a pension to get an additional 30-40% reduction in retirement income tax

If you want to compare IRP investment returns with deposit interest rates, see the deposit interest calculator.

Interim Severance Settlement — Conditions and Precautions

An interim settlement, which means receiving severance pay before leaving the company, is allowed only under specific conditions.

Permitted reasons for interim settlement (Article 8 of the Employee Retirement Benefit Security Act):

• Purchase of a home by a non-homeowner or payment of a rental deposit
• Medical expenses due to illness or injury of the employee or a dependent family member
• Declaration of bankruptcy or commencement of an individual rehabilitation procedure
• Wage reduction due to implementation of a salary peak system
• Recovery from disaster-related damage

If you receive an interim settlement, your years of service for that period are reset, which may reduce your deduction amount when you later retire. From a tax perspective, it is generally better to accumulate the funds in an IRP and manage them there.

Expert Summary

Severance pay is not simply "money you receive"; it is an asset where tax planning matters. The longer your service period, the lower your effective retirement income tax rate becomes, so staying employed longer is advantageous where possible. You can minimize your tax burden by using an IRP account to defer taxes and receiving the funds as a pension.

FAQ

Q1. Do I have to put my severance pay into an IRP? For retirement plan participants, severance pay of KRW 3 million or more must be transferred to an IRP. If the amount is under KRW 3 million or you are not enrolled in a retirement plan, you may receive it directly.

Q2. What is the difference between severance pay and retirement pensions (DC/DB)? Under the severance pay system, a lump sum is paid upon retirement. In a DC (defined contribution) plan, contributions are made each year and managed by the employee. In a DB (defined benefit) plan, the employer guarantees a certain benefit at retirement. In terms of returns, DC can be higher depending on investment performance.

Q3. Can freelancers or contract workers receive severance pay? If they are recognized as employees under the Labor Standards Act and work at least 15 hours per week for one year or longer, they can receive severance pay. For freelancers, the key issue is whether they are legally recognized as employees.

Q4. What should I do if my company does not pay severance pay? You can file a petition or complaint with the Ministry of Employment and Labor. Unpaid severance pay is subject to late-payment interest (20% per year).

Q5. What taxes apply if I withdraw severance pay early from an IRP account? If you make an early withdrawal, the full deferred retirement income tax plus other income tax of 16.5% may be imposed. From a tax perspective, it is generally better to receive the funds as a pension after age 55.

Q6. Are performance pay and bonuses included when calculating severance pay? Regularly paid bonuses are included. Irregular special performance bonuses may or may not be included depending on court precedents, so this should be checked.