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Severance pay

All journeys must eventually come to an end, and the employee journey is no exception. For employers in many industries, the end of an employee journey often involves distributing severance pay. Let’s take a closer look at the ins and outs of compensating your departing employees.

What is a severance package?

A severance package is an agreement between a company and its workforce to provide employees with some form of compensation in the event of a termination. In simpler terms, severance is pay given to an employee who no longer works for you. A severance package may be as simple as a lump sum of money, or it may involve more complex forms of compensation such as extended employee benefits, outplacement assistance to help find a new job, or various insurance benefits. The scope and amount of a severance package is generally decided upon by the employer and can vary widely between businesses and industries.

Who qualifies for severance pay?

With a couple of exceptions outlined below, there are no strict rules about who is required to receive severance pay. Decisions on what kinds of severance to offer, how much severance to offer, and whether to offer severance at all are at the discretion of the individual employer. Some companies offer severance packages to all workers who are laid off, while some offer severance only to management-level employees. Some employers may offer severance only after a certain number of years working for the company or in a certain role. Employee contracts and union rules may also require organizations to offer severance pay to some or all covered employees.

How does severance pay work?

Again, the specifics for distributing severance are mostly determined by the individual employer. For those that have one, an organization’s severance plans will usually be laid out in an employee handbook. Generally speaking, the severance payment process looks something like this:
  • The human resources department informs the employee of their pending termination
  • The employer offers a severance package as laid out in company documentation such as an employee handbook
  • The employee either signs a severance agreement to accept the payment or attempts to negotiate a payment that is more to their liking
  • Once the employer and employee come to an agreement, the severance is complete
It is important to keep in mind that in most cases a severance package is negotiable. Workers can hire an employment law attorney or attempt to negotiate terms themselves. Some common points of contention in these negotiations include:
  • Extensions of disability, life, and health insurance coverage
  • Extensions of retirement plans, employee pensions, and stock options
  • Retention of company-provided equipment such as tech devices
  • Assistance with outplacement services to help with a job search

What does a severance package include?

Once again, the specific provisions included in a severance package are up to the employer and may vary depending on the individual worker’s position, years of employment, or job performance. Most employers offer the employee’s regular rate of pay for a specific period (usually one or two weeks of pay) as well as some combination of:
  • Bonuses or extra pay for every year an employee has worked
  • Cash compensation accounting for any unused paid time off, such as vacation time, holiday pay, or sick leave
  • Compensation for health benefits such as medical and dental or life insurance
  • Payouts for retirement plans and stock options
Note that severance packages are taxable. Employers must record all severance payments when filing form W-2 and withhold all necessary federal and state taxes.

Is severance pay required by law?

It is a common misconception that severance packages are legally required under the Fair Labor Standards Act (FLSA) or some other regulation. Except for a very few specific circumstances, there are no federal or state laws in the U.S. that require employers to offer severance pay. In most cases, whether or not companies offer severance packages is up to the individual employer. Exceptions where severance is a legal requirement include:

Large-scale terminations

In some states employers are required to offer employees a modest severance package in the event of a large-scale termination event, such as the closing of a facility or a mass layoff. Under the Worker Adjustment and Retraining Notification (WARN) Act, a business that does not offer workers ample notice of a large-scale termination event may also be required to compensate with a severance package.

Employment agreements

If an employer has communicated at any point that severance pay is part of their company’s employment arrangement, they are legally obligated to abide by that assurance. This could include scenarios such as:
  • A union contract
  • An individual employee’s contract
  • Official company documents such as an employee handbook
  • A verbal promise from an employer to an employee
  • An established history of offering severance to employees in a substantially similar role as the employee being terminated
Even though severance packages are not legally required, many employers choose to offer them as a way to attract and recruit quality hires. Working for an organization is much more appealing if potential employees can be confident that they will be well taken care of when their employment with the company comes to an end. A clearly stated severance pay policy also serves as protection against possible lawsuits from former employees.

How does severance impact unemployment benefits?

A severance package can impact a worker’s unemployment compensation in several ways, depending on the form of payment.
  • A worker who receives severance as a lump sum is eligible to apply for unemployment insurance
  • If the employer disburses severance pay over an extended period, on the other hand, the employee technically remains on the company payroll and is therefore not eligible for federal or state unemployment until the payments have ended. The same rule applies to any accrued paid leave.
  • In other instances, a company’s severance agreement may require the employee to sign a contract stating that they have left their role voluntarily, making them ineligible for unemployment compensation.
These differences in approach underline the importance of educating employees thoroughly on your organization’s severance policies and the options available to them when their term of employment comes to an end.
Want to avoid severance packages and firing unproductive employees altogether? Check out our blog post "4 Ways Blue Collar Employers Can Improve Employee Relations".

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