Severance pay is typically provided for employees on the termination of employment. The size of the pay package is usually determined by the time served for which the employee is eligible when their role ends. 

While many employers offer severance packages, there’s no legal requirement in the Fair Labor Standards Act (FLSA) to provide severance. However, the Employee Benefits Security Administration (EBSA) may be able to assist workers who didn’t receive severance benefits under their employer-sponsored plan.

What is Severance Pay?

The term severance pay refers to any form of compensation that an employer provides their employees when their role at the company comes to an end. This pay will come in addition to what’s owed to the worker in remaining paychecks or unused holiday time and is usually reserved for employees who are laid off through no fault of their own. In some cases, severance pay is offered to employees who willingly resign. 

Severance pay packages generally consist of a cash payment as well as other potential benefits from employers. The amount paid, as well as additional perks, typically depend on employer policies. 

In most cases, employers will offer severance pay that provides one to two weeks’ worth of wages for each year of service a worker has provided the company.

Why do Employers Offer Severance Pay?

Many employers choose to offer severance pay to employees as a goodwill gesture to maintain a happy workforce. 

Although severance pay can be offered in a wide range of different circumstances, it can often soften the blow from an abrupt termination, as well as prevent future lawsuits from employees who may believe that they have a case for unfair dismissal. In many cases, workers will be required to sign a legal release in exchange for severance pay.

Anatomy of a Severance Pay Package

Severance pay packages can vary significantly depending on the company providing them. However, most severance considerations include: 

  • Severance pay, typically as a cash payment
  • Remuneration for unused paid time off (PTO)
  • Extended health insurance coverage
  • Extended dental, vision, and life insurance
  • Extended company perks
  • Outplacement services such as career counseling, training, and job placement assistance

Sometimes, employers will also allow their employees to keep company equipment, such as electronics or desks, supplied to home offices for remote workers. Most of these considerations will be covered in employee handbooks as part of wider company severance policies.

Taxing Severance Pay

Severance pay is taxed in the same bracket as earnings from full-time employment at an identical rate. However, this is only the case if severance pay is equal to the salary of the employee. For sums that equate to more or less than the employee’s salary, the earnings will be taxed in the appropriate tax bracket.

Legal Considerations

Although there’s no legal requirement to provide severance pay, the Fair Labor Standards Act (FLSA) stipulates that an employer must pay terminated employees through their last day of work. Employees must also be paid any accrued vacation time. 

With this in mind, it’s essential that businesses consider severance pay as a separate entity from the pay that employees are legally entitled to.

FAQs

Yes. Employees are free to negotiate severance pay both during the hiring process and once severance is offered after a layoff.

Severance pay should be regarded as an agreement between the employer and employee, and is usually outlined in an employment contract between both parties or established as part of a wider company policy.

If an employee believes that their severance pay is insufficient or is unhappy about the legality of their termination, they’re free to consult an attorney who may proceed with legal action against the employer.