Severance Pay 101: Severance Pay and How It Works

Thinking about receiving severance pay after a company terminates you from work is normal. While every situation is different, knowing the basics of severance pay help you know what to expect during this difficult adjustment. Losing a job is hard enough, especially with added uncertainty. Getting the full scoop on severance pay helps you feel more in control of your situation.

What Is Severance Pay?

Severance pay refers to pay and benefits employees receive when they leave a job involuntarily. This occurs during downsizing or restructuring. Companies provide severance to help employees during the transition to a new job.

How Does Severance Pay Work?

Companies often outline severance pay in an employment contract or company policy but are not legally obligated to grant it when not. Normally, severance equals one to two weeks of pay for every year of service.

Employees typically receive severance pay in one or two lump sum payments or installments. The amount depends on factors like tenure, position, and company policy. Long-term employees at higher levels receive more. Pay is commonly based on the employee's final salary.

Severance pay is taxable income. Companies deduct income and employment taxes on the severance pay received. Other severance packages allow employees to extend health insurance for a certain period. Companies also provide outplacement services to help with job hunting. In this case, the company covers all or part of the premiums. These are also taxable to the employee.

To receive severance pay, an employee must sign a severance agreement or quitclaim. This legally waives an employee's right to pursue legal action against the company. Failure to sign the agreement forfeits severance pay.

Severance Pay Eligibility: Who Qualifies and When to Expect It

Companies grant severance pay to employees laid off or terminated without personal fault. Eligibility for severance pay requires an employee to meet certain qualifying criteria.

Typically, full-time employees facing layoff or termination without cause qualify for severance pay. Part-time staff or those fired for disciplinary reasons do not qualify.

Severance pay amount varies based on factors like tenure, role, and company policy. Companies commonly offer severance packages to executives and tenured employees.

Companies have no legal commitment to offer severance pay. They can opt not to offer it at all. When offered, companies grant severance pay in an employee’s final paycheck or shortly after their last day of work.

How Is Severance Pay Calculated?

Companies calculate severance pay based on an employee's salary and tenure. The typical formula is:

• 1-2 weeks of pay for every year of employment. For instance, an employee with a 10-year tenure qualifies for 10-20 weeks’ severance pay.
• At times, it is a lump sum payment. In other cases, companies pay out severance pay in installments. The timing depends on the company policy and situation.
• It does not include additional compensation like bonuses, commissions, and benefits. Severance pay typically only includes the base pay.
• There is for negotiation. While companies have their standard formulas, employees sometimes negotiate for more, especially if they have substantial experience, seniority, or a desirable skill set. It does not hurt to have a respectful discussion about the amount offered.

Factors That Determine Your Severance Pay

Severance pay is often determined by various factors, including:

• Years of Service

Tenure is typically the biggest factor in determining severance pay. Longer-term employees receive more generous severance packages. This is because they have devoted more time and service to the company.

• Job Level

Higher-level employees, like executives and managers, frequently get larger severance payments. Their roles and responsibilities are greater, so their severance is higher to reflect that. Rank-and-file staff get the minimum required by law or company policy.

• Reason for Termination

Layoffs from downsizing or job elimination often result in more substantial severance pay. This is because the termination does not relate to performance. Employees fired for cause only receive the minimum or no mandated severance, depending on the company policy.

• Company Policy

Various companies have a standard severance pay policy based on job level, tenure, and reason for termination. A company policy aims to be fair and consistent. For key employees, companies negotiate enhanced severance packages. This is to secure release of claims and non-compete agreement.

• State Laws

Certain states enforce laws requiring minimum amount of severance pay, especially for mass layoffs. Companies must adhere to the laws of the employee’s respective state of work. Federal law does not require severance pay. But it has notification requirements for large-scale terminations or closures.

The thought of leaving a job evokes stress and anxiety. But understanding your rights and options regarding severance pay helps make the transition a little smoother.