Severance pay is typically offered to employees who are terminated through no fault of their own – for example, as a result of workforce reductions and displacements due to mergers or acquisitions. Employers are generally not required to extend severance pay to terminated employees, but it might sometimes behoove them to do so. This guide includes the circumstances under which you should provide severance to departing employees, as well as sample severance agreements and severance letter templates.
What is a severance package?
A severance package extends a monetary payment to an outgoing employee or group of employees, typically when they are terminated for business reasons, such as during a round of layoffs. Additionally, severance packages may be given to employees who are displaced by a merger or acquisition.
"Severance plans are generally used to provide some sort of financial support to employees who lose their job through no fault of their own," Amanda Gee, an HR coach at Paychex, told business.com. "What usually comes in return … is the employer gets a waiver of legal claims connected with the employment relationship."
When a departing employee signs a severance agreement, they typically agree to waive any discrimination or wrongful discharge claims they might otherwise make, Gee said. Then, they receive the payment outlined in the severance agreement.
What should be included in a severance package?
Determining how much money should be included in a severance package is fairly straightforward. According to Gee, employers typically provide one to two weeks of an employee's pay for each year they've worked for the company. For example, an employee of five years who made $500 per week might receive between $2,500 and $5,000 in severance pay.
"A business can factor in the minimum amount of severance they'll offer and a maximum they'll pay regardless of years in service," Gee added. This ensures that when a decades-long employee departs, businesses won't be on the hook for outrageous sums.
Additionally, severance packages must include a payment or benefit an employee wasn't already entitled to, Gee said. For example, including an employee's final paycheck in a severance payment would not qualify because the employee is already entitled to compensation for the hours they worked before departing the company.
In some cases, businesses might also choose to include a continuation of benefits, such as medical insurance, as part of a severance agreement.
How are severance packages paid?
Businesses have some flexibility in how they pay severance packages. Some companies might offer a lump sum to departing employees, while others might opt to issue smaller payments over time through regular payroll periods.
"This is where attorneys and CPAs come in," Gee said, adding that legal counsel should be consulted during the development of severance pay policies. "There are some benefits to doing either/or."
Severance package payments are also subject to taxes under federal and applicable state law, Gee said.
Severance packages are fulfilled separately from the termination itself, said Moses Balian, HR consulting manager at Justworks. That means an employee could be dismissed from the company before the severance agreement is signed and the severance pay is delivered.
"Both of those things may very well come weeks after employment is terminated," Balian said.
How should you communicate severance pay to your employees?
When terminating an employee, you must carefully document all communications leading up to and surrounding the termination. The same is true when discussing severance pay. Balian recommended spelling out everything in writing.
"Separation agreements constitute a legal document," Balian said. "Therefore, they must be expressed in writing. Generally, they are presented to employees during or at the end of the termination conversation itself. Alternatively, the host of that conversation might say a severance package is forthcoming and they will be in touch shortly with the details."
Communicating severance packages to employees clearly, succinctly and in writing is an important step in the process. Employers must be able to document the entire termination process in order to protect against any potential liabilities.
Additionally, it is important to be considerate when communicating with employees, especially during a reduction in force, Gee said. Offering an open forum to explain the situation, as well as setting aside time for one-on-one questions, is not only ethical but can also help buoy the morale of the employees you are retaining.
"The severance agreement and those types of meetings are better had on an individual basis, as much as you can do that," Gee said. "Employees deserve the opportunity to talk one on one. This is their livelihood, and people don't usually like to ask those questions in a group setting."
Are severance packages required by law?
There is no requirement under the Fair Labor Standards Act or other federal law mandating that employers provide severance packages. However, if an employer fails to provide proper notice to terminated employees under the Worker Adjustment and Retraining Notification Act of 1988, they may be required to extend severance pay.
Several states – including Massachusetts, Idaho, Maine and Rhode Island – maintain severance pay laws. In the case of Massachusetts and Rhode Island, a federal court has ruled that state law is preempted by the Employee Retirement Income Security Act, making those laws unenforceable.
"Generally speaking, private-sector employers are not beholden to any requirements around severance under federal and state law," Balian said.
In January 2020, New Jersey became the first state in the nation to require severance pay regardless of how much advance notice employers give terminated employees. The Garden State mandates that employers that give terminated employees at least 60 days' notice must pay one week of severance per year of service, while those that fail to give advance notice must pay four weeks' severance pay.
According to Balian, there are circumstances under which it's permissible for employers to withhold severance pay.
"It is by nature part of the tit-for-tat where funds are offered in exchange for a waiver of claims," he said. "If someone fails to accept the terms of the termination agreement, they will not receive severance."
This could include contingencies, such as requiring company equipment to be returned or the employee to sign a nondisclosure agreement. However, if an outgoing employee signs the agreement and abides by its terms, they would be entitled to severance.
Should you develop a severance package policy?
There is no requirement to develop a policy around severance packages. Moreover, if the majority of your employees are at-will, there might not be much of a need for a dedicated severance pay policy. However, if you do craft a policy, you should apply it consistently and without exception, Gee said.
"If [an employer] is going to put together a policy that they offer severance to all employees, they have to be cautious that they're not using discriminatory factors or appearing inconsistent," she said. "If the company makes the decision to offer all employees severance packages, that's fine … but they have to make sure they're not violating any laws by selecting who they apply severance to."
Companies that decide against crafting a severance pay policy can simply draft one-off severance agreements should the need arise. These can be developed on a case-by-case, individualized basis, thus giving companies greater flexibility to customize the terms for each circumstance.
"If a business is worried … that there is some exposure to liability and want to use a severance agreement to mitigate those exposures, that's a one-off situation," Gee said. "They may use severance only on an as-needed basis."
Example of a severance package agreement
A severance agreement is a legal document signed by both the employee and the employer. It typically outlines the exchange of severance pay and the liability waiver between both parties and serves as a legally binding contract between the two. Always consult an attorney before finalizing any legal documents.
A severance agreement should include the following elements:
- The name of the employer and employee
- The effective date of the agreement
- The employment period of the outgoing employee
- The severance pay amount
- Terms of continuation of benefits
- Employee waiver of legal claims
- Additional terms, such as whether severance pay is contingent on the return of company equipment
- The dated signatures of the employer and the employee
This example of a severance package agreement from Betterteam outlines what a final draft of an agreement might look like.
Additional resources for severance pay packages
If you're looking for additional resources for crafting a severance package, severance agreement or employee termination letter, these online resources can help guide you further: