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Given following situation
A Company has an employee (Bob) who will retire in 3 years. The company decides to save costs and therefore does downsizing. They offer Bob an severance payment in the amount of 3 annual salaries, if he leaves the company.

Question
Assuming that Bob is a valuable employee who does a good job - how does it make sense (for a company) to let him go and give him the same amount of money as when he still worked for the company?

If relevant: we assume Bob lives in Germany.

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    $\begingroup$ Not being familiar with Germany, could you clarify how much taxes a company pays for an employee? In France, it's expected that a company pays about as much in taxes as it gives the employee, so in your scenario the company would save 50% of expenses. $\endgroup$ – Matthieu M. Nov 4 '20 at 20:43
  • $\begingroup$ @MatthieuM. in Germany the additional costs of employment apart from the gross salary are about 60-70 percent, too. Even though taxes are paid by the employer, they do it out of the employee's pocket. It's social security and such, that increases the total cost. - BUT: It is pretty much irrelevant, if you pay that in one year or over the course of three years. $\endgroup$ – I'm with Monica Nov 5 '20 at 10:03
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    $\begingroup$ In Germany, tax needs to be paid on severance payments, but, in most cases, no social security (e.g. finanztip.de/steuererklaerung/abfindung-versteuern, in German). As social security payments are approx. 40% of total salary/wages, paid half by the employee and half by employer, paying €10K severance gets Bob €10K minus tax. Paying €10K salary costs the employer €12K including social security and gives Bob €8K minus tax. Giving Bob €8K severance is still a good deal for Bob (he can stop working) and saves the employer €4K. $\endgroup$ – Guntram Blohm Nov 5 '20 at 10:34
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If Bob is actually a valuable employee this probably doesn't make sense.

However it is possible that the things Bob is good at just don't have a market any more. So his work could be good but it is not valuable (any more). Training his to do new things is not considered worthwhile with his upcoming retirement.

If he continues to work he probably also needs an office or similar amenities that are not needed if he is let go.

So one could construct examples where it is worthwhile to pay him his full salary until retirement as severance pay but it wouldn't be a typical situation.

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You should also consider that firms often need to use other factors together with employees/labor. Steel manufacturers can't produce steel just by hiring workers without some steel furnace/capital. If one furnace becomes too expensive to maintain it could be cheaper to scale down and using that furnace even if the company will still pay all the employee wages because this still reduces costs. In such cases it might not matter how good the employees are at their job.

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If bob is leaving in 3 years, it may be worth it to pay him 3 years salary to retire early. If his skills/area of expertise are far out of date, it might be better to go ahead and get a new, younger person started with updated skills in a new area of business, and in 3 years that new person will have a lot of experience.

A business could also do this just to trim down overhead. Bob has to have a manager, consume office supplies, require a desk/cubicle (in downtown areas this can be pretty expensive), require tech support, need new computer equipment, require medical insurance or other govt mandated taxes (payroll tax in US). All of this can add up to over 100% of Bobs salary, or in other words Bobs salary is only 50% of the total cost to keep him employed and not replace him.

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tl;dr privatizing gains and socializing costs.

The other answers already list a number of costs which are no longer applicable, especially the common costs for having an employee (manager, office, ...).

Payroll tax (Lohnsummensteuer) was abolished in Germany from 1980 on, due to its negative effect on employment. It was deemed better to have an employee pay income taxes and the social security duties by lowering the cost of employment.

There are four big social security duties in Germany. For people with income the payment is a percentage of the income, shared by employer and employee.

  • Rentenversicherung (old age pension)
  • Krankenversicherung (medical insurance)
  • Arbeitslosenversicherung (unemployment insurance)
  • Pflegeversicherung (nursing insurance)

Except for medical insurance these costs disappear without income, medical insurance is reduced to a nominal sum. The pension will be lower because of the missing years, but sometimes there were special laws waiving that deduction. Politicians used tax money to compensate, because it polished the unemployment numbers, expecting the lost job to be replaced by someone else.

Bob would also save some cost for no longer having to commute to work. And of cause have a lot more free time to do whatever.

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