What is severance pay?
Severance pay is the compensation an employer provides to an employee after their working relationship ends. This is typically because of an involuntary termination outside of the employee’s control, such as a layoff or company downsizing. In some cases, severance pay can also be offered to employees who are retiring. But it’s not usually offered to someone who’s been fired for misconduct.
Severance packages can provide financial support and other benefits while former employees search for a new job.
What you’ll learn:
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Severance pay isn’t required by law, but employers may offer it as a way to attract prospective employees and help protect the company from potential lawsuits.
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The amount of severance pay offered is usually based on the employee’s years of service and sometimes on experience.
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Severance packages can include compensation and extended benefits. The details are often included in an employment contract.
Is severance pay required by law?
There’s no requirement under the Fair Labor Standards Act for employers to pay employees severance. But some companies may offer it as a way to show support to soon-to-be former employees—especially those with longer tenures—through financial compensation and other benefits.
It can also protect a company’s reputation and image for future recruiting efforts. Companies might also use severance packages as possible protection from lawsuits by having the employee sign a release before accepting the package.
How does severance pay usually work?
Typically, the amount of severance pay is based on the employee’s years of service or experience. It can either be paid in a lump sum or be offered over a period of time in installments.
Does severance pay affect unemployment benefits?
Unemployment eligibility may be affected by severance pay, depending on how it’s been paid out and state-specific regulations. For example, in certain states, receiving severance pay as a lump sum may not impact benefits. On the other hand, a salary continuation over a period of time may cause a delay or reduction in benefits.
What is a typical severance package?
Typical severance packages include one to two weeks of pay for each year of service and may include other benefits. The details can vary between companies and are usually in an employment contract.
Here are some examples of the types of compensation that may be included in a severance package:
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Salary continuation: An employer may continue to pay an employee’s salary for a certain amount of time based on the length of time the employee has worked for the company, their experience level or their position.
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Unused paid time off or vacation time: Not all states require employers to pay for an employee’s accrued time off when their employment ends. But some employers may include accrued vacation time, sick days and holiday pay in their severance packages.
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Extended health insurance coverage: The Consolidated Omnibus Budget Reconciliation Act (COBRA) was designed to make sure employees who leave their job, either voluntarily or involuntarily, have the opportunity to continue their health coverage. Employers may offer to pay some or all of the employee’s COBRA premium as part of a severance package.
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Uncontested unemployment benefits: When their employment ends, an employee may file for state unemployment benefits. Before the claim goes through, the employer can contest the request for benefits, depending on the circumstances. In some severance packages, employers will agree not to contest the unemployment claim.
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Other types of severance compensation: A severance package may include other types of benefits, such as job search assistance, flexibility or time off while an employee looks for a new job, or the transfer of company assets—like a cellphone. It could also include a continuation of additional benefits like dental insurance and life insurance.
Severance pay and benefits FAQ
Still wondering about severance pay? Here are the answers to some common questions:
Is severance pay taxable?
Yes, severance pay—including compensation for accrued vacation and sick time—is generally taxable in the year it’s received. It’s subject to tax withholding depending on how it’s paid out. If an employer pays the severance as part of normal wages, it’s typically subject to the employee’s withholding amount, which is based on their tax bracket. If the employer pays the severance separately from normal wages, it’s generally taxed at a flat rate of 22%.
How is severance pay used with an early retirement offer?
Companies may present an early retirement offer to employees with long tenure as a way to cut costs. Early retirement offers may include severance pay based on years of service—and the payout may be higher in an early retirement offer.
How can severance pay be used?
Severance pay can be used as a financial cushion while an employee looks for another job. It can be helpful for an employee to take this time to update their resume or CV and write cover letters for any jobs they may apply for. It’s also a good idea to keep in contact with colleagues and ask for letters of recommendation to use when looking for new opportunities.
Key takeaways: What is severance pay?
Severance pay can help an employee whose employment ends due to layoff, downsizing or retirement by providing some support. It can also protect the employer from any potential legal troubles after ending a working relationship with an employee.
Whenever you’re starting a new job, it’s a good idea to review the benefits laid out in the company’s employment contract, like the terms of severance pay or vesting periods for retirement funds.
