Severance Pay and Supplementary Pensions

Reading time 4 minutes

Published on 09/07/2025

Like Aesop's prudent ant, it's wise for us to set something aside for the future. If you're an employee in Italy, part of your savings is automatically built up through the Trattamento di Fine Rapporto (TFR), or severance pay - an amount your employer sets aside during your working life and pays you when your employment ends, either because you change jobs or retire. Let's take a closer look.

A brief history

Severance pay was first introduced in 1919, after the First World War, as compensation for workers dismissed without just cause, and also as a deterrent against unjustified dismissals. In 1942, it became a length-of-service indemnity, linked to years of employment and gradually acquiring a social protection function. By the 1960s, the entitlement was extended to cover dismissals for just cause as well.

The current version of TFR dates back to 1982, and applies to private sector employees. It functions as a form of compulsory saving, with employers required to set aside an amount equal to approximately 7% of the employee's salary. This sum is then paid out when the employment ends.

Nowadays, however, you can choose to use this nest egg differently. Here's how.

TFR: a decision to make

If you work in the private sector, you must decide within six months of being hired what to do with your TFR. You have two options:

• Leave it with your employer. In this case, your employer keeps the amount and pays it to you as a lump sum when you leave your job.
• Pay it into a supplementary pension scheme. The money is transferred to a pension fund, which will provide you with additional income on top of your state pension.

If you don't make a choice within six months, your TFR will automatically be transferred to the pension fund specified by your collective labour agreement or, if there are several, to the one with the most members at your workplace. If no fund is specified, the money will be directed to a default scheme set out by law.

If you initially choose to leave your TFR with your employer, you can later decide to transfer it to a pension fund - but not the other way round.

Please note that public sector employees are subject to different rules. The procedures and timing can vary depending on the category of employment.

What's the difference between the two options? Returns and taxation

1. Leaving your TFR with your employer. The amount set aside grows each year by a fixed 1.5% plus 75% of the annual inflation rate. When you retire, the TFR is taxed separately from your other income, using the average personal income tax (IRPEF) rates applied over the previous five years.
2. Paying your TFR into a pension fund. In this case, your savings grow based on the performance of the investments made by the fund you choose. Taxation is more favourable: the maximum rate is 15%, and it may be reduced to 9% if you contribute for more than 35 years. When you retire, you can choose - within certain limits - how much of your supplementary pension to take as a lump sum and how much as regular monthly payments to top up your state pension.

Why pay your TFR into a pension fund?

In the past, the Italian public pension system provided a net replacement rate - that is, the ratio between your first pension and your final net salary - of over 80%. So, if your net monthly wage was €2,000, your first pension might have been around €1,600.

However, this ratio is steadily falling. For those retiring after 2040, it may fall below 70%, and it could decline further in future. If your income drops from €2,000 to €1,400 a month, you might need to make significant adjustments to your lifestyle - unless you have additional savings or income to bridge the gap.

Beyond TFR

To build up further savings for retirement, you can also make voluntary contributions to a pension fund on top of your TFR. These are exempt from income tax (IRPEF) up to a maximum of €5,164.57 per year. In addition, if you make voluntary contributions, your employer is often required to contribute as well. This employer contribution is a valuable benefit that helps grow your retirement fund.

Ultimately, your supplementary pension will depend on:

• the amount of TFR paid into the fund;
• your voluntary contributions;
• your employer's contributions;
• the investment performance of the pension fund;
• the tax treatment;
• the fund's management costs, which you should always calculate.

Should you keep your TFR with your employer or join a pension fund?

There's no one-size-fits-all answer. It depends on several factors: your age, how close you are to retirement, the tax benefits available, your tolerance for financial risk, and - most importantly - how the pension fund's investment returns compare with the TFR's annual revaluation rate.

Over the long term, a pension fund is likely to offer better returns than leaving your TFR with your employer. And if you factor in the additional contributions from your employer and you still have many working years ahead, joining a pension fund is certainly worth serious consideration.

This is just a brief overview of a complex but vital subject for your future financial wellbeing. What really matters is that you are aware that this is an important decision.

To find out more, a good starting point is the Introductory Guide to Supplementary Pensions, available on the website of COVIP, the supervisory authority for pension funds in Italy.