What Is the Statutory Severance Calculation Formula in China?
Severance pay in China, known as 经济补偿金 (jīngjì bǔchángjīn, economic compensation), is a statutory payment employers must make when terminating an employment contract under legally defined circumstances. The core formula is straightforward: years of service × average monthly salary of the last 12 months. However, two important caps apply. For example, a non‑high‑income employee with 5 years of service earning 20,000 RMB/month receives a severance of 100,000 RMB (5 × 20,000) – a specific number that illustrates the base calculation.
Under the Labor Contract Law (劳动合同法, láodòng hétóng fǎ) and its Implementing Regulations, severance is calculated differently for ordinary employees versus high‑income earners. Employers must also understand when severance is mandatory – and when it is not. This FAQ provides the exact formula, explains the caps with real numbers, and highlights common mistakes that can lead to costly disputes.
Base Calculation Formula for Ordinary Employees
For employees whose average monthly salary does not exceed 3 times the local average monthly salary (of the previous year), the formula is:
Severance = Number of full years of service × Average monthly salary (last 12 months before termination)
The number of years is calculated as follows: any period shorter than 6 months counts as 0.5 years; any period of 6 months or more counts as 1 full year. For example, an employee with 2 years and 7 months of service receives severance for 3 years. The average monthly salary includes wages, bonuses, allowances, and other monetary compensation paid during the final 12 months.
Special Rules for High‑Income Employees (3× and 12‑Month Caps)
If the employee’s average monthly salary exceeds 3 times the local average monthly salary, two caps apply simultaneously:
- Salary cap: Only 3× the local average monthly salary is used as the base for calculation.
- Year cap: The maximum number of years counted is 12, regardless of actual length of service.
For instance, in Shanghai (2024 local average monthly salary ≈ 12,183 RMB), a high‑income employee earning 50,000 RMB/month with 15 years of service would have a capped base of 36,549 RMB (3×12,183) and a capped year count of 12, resulting in a severance of 438,588 RMB – not 750,000 RMB (15×50,000). This cap ensures that severance remains proportionate and is designed to protect both parties from excessive payouts.
When Severance Is Not Required
Employers do not need to pay severance in the following situations:
- Employee voluntarily resigns (unless forced by employer misconduct).
- Employee is terminated for gross misconduct (e.g., serious violation of company rules, criminal offense).
- Employee is on fixed‑term contract and the contract expires naturally and the employee does not wish to renew (under certain conditions – if the employer renews at equal or better terms and the employee refuses, severance may not be required).
- Contract ends due to retirement or death.
If the employer terminates the contract without legal cause, the employee is entitled to double severance as a penalty (赔偿金, péichángjīn, compensation).
Tax Treatment of Severance Payments
Severance is generally tax‑exempt up to a limit: the local average monthly salary (of the previous year) multiplied by 3, times the employee’s years of service. Any amount exceeding this threshold is treated as ordinary income and subject to individual income tax. For example, in Shenzhen (local average salary ≈ 13,000 RMB), an employee with 10 years of service can receive up to 390,000 RMB (13,000 × 3 × 10) tax‑free. Above that, the excess is taxed at the employee’s marginal rate.
Example: Severance Calculation Table
| Scenario | Years of Service | Avg Monthly Salary (RMB) | Cap Applied? | Severance Amount (RMB) |
|---|---|---|---|---|
| Ordinary employee in Beijing (cap = 3×11,000 = 33,000) | 6 | 25,000 | No (25,000 < 33,000) | 150,000 (6×25,000) |
| High‑income employee in Shanghai (cap = 3×12,183 = 36,549) | 15 | 50,000 | Yes (salary and year caps) | 36,549 × 12 = 438,588 |
| Short‑service employee (less than 6 months) | 0.5 (4 months) | 10,000 | No | 5,000 (0.5×10,000) |
Pitfalls in Severance Calculation
Cost: Underpayment of severance by 0.5 months of salary – up to tens of thousands RMB for high‑earners.
Fix: Apply the rule: any period of 6 months or more counts as 1 full year; less than 6 months counts as 0.5 year.
Cost: Overpayment of severance – possibly hundreds of thousands RMB for senior executives.
Fix: Always check the official local average monthly salary published by the provincial statistics bureau for the preceding year. Apply the 3× cap and the 12‑year cap simultaneously.
Cost: Inaccurate calculation – at least 5‑10% deviation in severance amount.
Fix: Use only monetary compensation that is part of the normal salary structure: base salary, performance bonuses, commissions, and regular allowances. Exclude reimbursements, quarterly bonuses that are discretionary, or gifts.
Next Steps
- Download our Labor Contract Essentials Guide – Ensure your employment contracts include clear termination and severance clauses. Read: Labor Contract Essentials
- Review the full Termination Process Checklist – Avoid procedural mistakes that could double your severance liability. Read: Termination Process Checklist
- Assess Foreign Employer Compliance – If you are a foreign‑invested enterprise, ensure your HR practices align with Chinese labor law. Read: Foreign Employer Compliance Guide
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