What Severance Pay Rules Must Employers Follow in Iceland?

Which Employees Qualify for Severance Pay?

• Employees whose contracts, offer letters, or company policies explicitly promise severance on termination.
• Employees covered by Icelandic collective bargaining agreements that include severance or enhanced termination packages.
• Employees dismissed for economic, organizational, or operational reasons where you negotiate a separation package to avoid disputes.
• Long-serving employees where your company has an established practice of paying severance, creating an implied expectation.
• Senior managers or specialists whose negotiated contracts often include severance, garden-leave, or enhanced notice terms.
• Employees agreeing to a mutual termination or settlement agreement that specifies a severance amount and payment schedule.

What Are the Legal Timelines for Paying Severance?

Because Iceland does not mandate statutory severance, payment timelines are mainly driven by what you agree in contracts, collective agreements, or settlement documents. In practice, severance is usually paid as a lump sum on or shortly after the last working day, often together with the final salary and payment in lieu of unused holiday. You must still respect statutory or agreed notice periods, during which normal salary and benefits continue. Collective agreements may set stricter deadlines for paying all final entitlements, so you should check the relevant union agreement before processing terminations. To reduce legal risk, your company should document the payment date in writing and ensure funds are transferred no later than the employee’s final pay cycle.

What Penalties Apply if Severance Is Not Paid Correctly?

If you mishandle severance or final pay in Iceland, the main risks come from breaching collective agreements, written contracts, or statutory rules on notice, holiday pay, and working terms. Employees can challenge the termination, claim unpaid amounts, and seek damages, and unions may support or escalate disputes on their behalf.

• You may be ordered to pay outstanding amounts plus interest and possible compensation.
• Breaches of collective agreements can trigger union pressure, grievances, or industrial action.
• Unfair or badly documented dismissals increase the risk of reinstatement claims or higher settlements.
• Repeated non-compliance can damage your reputation with unions, authorities, and future hires.
• Legal disputes consume management time and increase legal and advisory costs.

Does Outsourcing Employment via an EOR Change Severance Liability?

Using an Employer of Record (EOR) such as the service described at https://www.playroll.com/employer-of-record does not remove the need to follow Icelandic termination and working-terms rules. In a compliant EOR model, the EOR is the legal employer in Iceland and is responsible for issuing contracts, applying the correct collective agreement, and calculating notice and final pay. However, your company still directs day-to-day work and business decisions, so you can be drawn into disputes if terminations are unfair or poorly documented. You should align with the EOR on who approves dismissals, how packages are calculated, and when payments are made. Clear service agreements and workflows help ensure that both you and the EOR handle severance-related obligations consistently and defensibly.

Be 100 Percent Compliant in Offering Severance with Playroll

Playroll helps your company navigate Iceland’s mix of statutory rules and collective agreements so you do not miss hidden obligations around notice, holiday pay, and final settlements. Our team tracks which sectoral agreements apply, how they interact with the Act on Working Terms and Pension Rights Insurance, and what market-standard severance looks like for different roles. You get practical guidance on when to offer severance, how to structure it, and how to document mutual terminations or redundancy programs.

By centralizing your Icelandic employment through Playroll, you reduce the risk of inconsistent practices and ad hoc deals that can later be challenged. We coordinate with local experts to ensure final pay, benefits, and any agreed severance are calculated correctly and paid on time. Your HR and finance teams gain clear workflows, predictable costs, and documentation that stands up to scrutiny from employees, unions, or authorities.