What Is a Severance Package and Severance Agreement?

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, regional HR coach at Paychex, told us. “What usually comes in return … is the employer gets a waiver of legal claims connected with the employment relationship.”

In years past, when a departing employee signed a severance agreement, they typically agreed to waive any discrimination or wrongful discharge claims they might otherwise make. However, if you’re thinking of using a severance package to buy the silence of ex-employees, you might want to reconsider.

The National Labor Relations Board (NLRB) ruled that “employers may not offer employees severance agreements that require employees to broadly waive their rights under the National Labor Relations Act.”

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 businesses won’t be on the hook for outrageous sums when a decades-long employee departs.

Additionally, severance packages must include a payment or benefit an employee wasn’t already entitled to. 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. [Read related article: The Process for Terminating Employee Benefits]

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 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. [Read related article: How To File Payroll Taxes: Steps and Best Software for Filing]

Severance packages are fulfilled separately from the termination itself, said Moses Balian, certified HR consultant 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 essential 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 (FLSA) 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 (WARN) of 1988, they may be required to extend severance pay.

State severance pay laws

New Jersey is the only U.S. state to require certain businesses to provide severance pay, primarily in the instance of plant relocation, plant shuttering or mass layoffs affecting 50 or more employees. The Garden State mandates that employers that give terminated employees at least 90 days’ notice must pay one week of severance per year of service, while those that fail to give advance notice must provide another four weeks of severance pay. However, New Jersey is a bit of a unique situation compared to other states.

“Generally speaking, private sector employers are not beholden to any requirements around severance under federal and state law,” Balian said.

Although there are generally no other state laws making severance pay mandatory, when offered a severance package, most employees are given 21 days to accept or decline it. Additionally, most states do have other forms of pay laws that affect severance pay, such as severance paycheck deadlines.

For example, some states (California, Colorado, Hawaii, Illinois, Massachusetts, Missouri and Montana) require employers to pay terminated employees their severance paychecks immediately, whereas others require payment on the next payday or within 24 hours to seven days.

Alabama, Florida, Georgia and Mississippi do not have final paycheck deadlines for severance pay.

Withholding 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?

Other than certain instances in New Jersey, developing a policy around severance packages is not required. Moreover, if most of your employees are at-will, there might not be much 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 wants 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 (within reason)
• Additional terms, such as whether severance pay is contingent on the return of company equipment
• The dated signatures of the employer and the employee

Here’s a template of what a severance package agreement and termination letter might look like:

[Company Letterhead]

[Date]

[Employee Name] [Employee Address] [City, State, ZIP]

Dear [Employee Name],

This letter confirms our discussion today regarding the termination of your employment with [Company Name], effective [Date] (the “Termination Date”). This decision is final and is due to [brief reason if applicable, such as “organizational restructuring” or “position elimination”].

Severance Package Details:

1. Severance Pay
   • You will receive [X] weeks of severance pay, calculated based on your current base salary of $[amount] per year.
   • Total severance amount: $[amount]
   • Payment will be made [in a lump sum/in regular payroll installments] on [date/schedule]
   • All applicable taxes and withholdings will be deducted.
2. Benefits
   • Health insurance coverage will continue through the end of [month].
   • You are eligible for COBRA continuation coverage thereafter.
   • Information regarding COBRA will be sent to you separately.
3. Additional Compensation
   • Payment for accrued but unused vacation days: [X] days totaling $[amount]
   • Pro-rated bonus (if applicable): $[amount]
4. Company Property — Please return all company property including:
   • Laptop and other electronic devices
   • Security badges and keys
   • Company credit cards
   • Any confidential documents or materials
5. Final Paycheck
   • Your final paycheck for work through the Termination Date will be issued on [date], according to state law requirements.

To receive the severance package outlined above, you must sign and return the attached Separation Agreement and General Release by [date]. The agreement includes important information about your rights and obligations, including confidentiality and non-disparagement provisions.

We encourage you to review the Separation Agreement carefully and consult with an attorney before signing. You have [number] days to review this agreement and [number] days after signing to revoke your acceptance.

Our HR department is available to answer any questions about your separation package or final arrangements. Please contact [HR Contact Name] at [phone/email].

We appreciate your contributions to [Company Name] and wish you success in your future endeavors.

Sincerely,

[Name] [Title] [Company Name]

Before creating and sending an official document like this for your business, consult with your attorney to make sure it checks all the right legal boxes.

Skye Schooley and Tejas Vemparala contributed to this article. Some source interviews were conducted for a previous version of this article.