How Does Severance Work: Everything You Need to Know
How does severance work? It's helpful to know what severance is and how it works to efficiently plan for it.8 min read
2. What Does Severance Include?
3. Typical Severance Pay Formulas
4. Who Is Eligible to Receive Severance Pay?
5. How to Get the Best Severance Deal
6. Consult a Lawyer
7. Who Negotiates?
8. Unused Options and Benefits
9. Protect Your Freedom to Earn a Living
Updated November 24, 2020:
How Does Severance Work?
Many individuals have wondered, “How does severance work?” It's helpful to know what severance is and how it works to efficiently plan for it. Taking a deeper look, severance is a policy that some companies give to a terminated employee and varies from company to company.
Severance kicks in once an employee are terminated, especially when the said employee is let go due to reasons or faults, not of their own, and the employee has worked for the company for a determined (and lengthy) period of time.
What Does Severance Include?
Severance pay is not a required policy according to the Fair Labor Standards Act (FLSA). How and whether a company decides to grant this pay is at its discretion. Should it be an option, the amount one actually receives depends on many factors:
- Is the employee paid hourly or on salary?
- Is the position lower-level or C-level/upper management?
- What are the reasons and/or circumstances for the employee's dismissal?
- How long has the employee worked at the company?
The company's employee manual or personnel policies may have a written section on severance. Its policy may state that severance pay is granted based on a particular case or situation. Employers acknowledge how difficult the layoff process can be on both affected workers and employees that remain in the company. A justifiable reason must be documented for the layoff and how it affects various protected classes like gender, age, national origin, and race.
Executives and HR professionals typically agree on a formula of how to offer a severance agreement that is fair and equitable given the circumstances. Typical severance agreements include, but are not limited to:
- Severance pay terms
- Vacation pay
- Benefits information, like COBRA
- Return of property
- Confidentiality agreement
- Non-compete clause
- Unemployment information
- Release of claims
- Covenant that protects against a lawsuit
The financial components of a severance package can also include:
- Pay based on terms of service
- Commissions or bonuses and any deferred payouts due
- Profit-sharing and 401(k) plan, based on rights under pension
- Stock/restricted stock options and exercise/acceleration schedules
- Terms for loan repayment
- Unreimbursed business expenses
Many employers expect expense sheets to be submitted and completed as part of the release process. Make sure you know when these are due to your employer. A company may offer severance pay in exchange for getting you to agree that you won't sue for things like discrimination, unpaid wages, or wrongful termination.
The compensation an employee receives varies across industries and roles. It is usually determined by the amount of time someone has been employed, for example, a week to two weeks of salary for every year of employment. On the one hand, you can't collect unemployment insurance while you are receiving severance. On the other, it's important to thoroughly read and understand what you're signing "because you may be giving up certain rights by accepting the package," including your ability to work for certain employers in the future.
Typical Severance Pay Formulas
While your final number will vary from other employees receiving severance, most companies use a pretty standard formula for calculating the amount each worker will be paid:
- For hourly employees, the typical calculation looks like this:
Number of years with company X 1 week of regular pay = Severance Pay $ Total
So, if you typically make $800 per week and have worked at your company for five years, your severance pay would be $4,000. (5 years X $800 = $4,000)
- For salaried employees, the typical calculation looks like this:
Number of years with company X 2 weeks of regular pay = Severance Pay $ Total
Let's say your salary is $80,000 per year. That works out to about $1,600 per week or $3,200 for two weeks. If you have been with your company for five years, your severance pay would be $16,000. (5 years X $3,200 = $16,000)
If you are part of upper management, however, your severance pay could be much higher.
Severance packages for management can range from six months to a year of pay, or even higher. According to a 2009 study by Manpower Co.'s Right Management, U.S. severance averages 2.5 to 3 weeks of pay per year of service for "involuntarily separated" top and senior executives, and 1.4 to 1.8 weeks for others.
Who Is Eligible to Receive Severance Pay?
Although employers are not required to do so by law, many give severance pay to some or all permanently laid off or terminated employees. Even if your employer doesn't offer severance pay, or you are not eligible based upon company policy, you can try to negotiate for more severance than the company offers. This is especially true if you have been with the company for a long time, have served as a team leader or upper management, have a commendable service record, or have brought in large clients for the company.
Sometimes, employees who have quit their jobs because of intolerable working conditions can also negotiate for more severance pay than would normally have been provided. If you are an employee at-will, your employer can terminate you at any time, without notice and with or without severance. Sometimes, employees who have been terminated due to a workforce reduction are eligible.
Most severance agreements include the key information you need to apply for unemployment.
Most states don't allow you to collect unemployment while you are also collecting severance pay, so check with your local unemployment agency for specific information. Under the WARN Act (Worker Adjustment and Retraining Notification), if your organization has over 100 employees and is preparing to lay off a lot of people, your employer is required by law to give you 60 days' notice of a company closing or a large departmental closing.
If you're a "fired or laid-off employee, you don't have a ton of bargaining power." If your employer fails to give you the required notice, then you are legally entitled to severance pay under WARN (Worker Adjustment and Retraining Notification) Act. Also, an individual or union contract might require severance, and if your employer has a severance pay policy in its employee manual, it generally must comply with that policy, says New York lawyer Wayne N. Outten.
How to Get the Best Severance Deal
The most important thing to remember when being offered a severance pay amount is that nothing is set in stone. If an employer cannot offer you more money, request additional perks like extended health care benefits, job placement services, or even equipment like your company cell phone and laptop. In today's economy, just about anyone can be dealt a layoff hand at any time.
While HR will tell you it has a set calculation, you should always ask for more. When Léo Apotheker became the latest CEO to be ousted by Hewlett-Packard HPQ's board in September, his severance package included:
- $7.2 million to be paid out over 18 months;
- a $2.4 million bonus for 11 months of service;
- more than $3.5 million worth of restricted stock; and
- relocation expenses, including $300,000 to cover losses or other expenses related to the sale of his California home, and HP agreed to pay for his legal fees to negotiate the package.
Moreover, according to an HP filing, not all of the benefits Apotheker got were in his contract—some were negotiated after he was fired.
Consult a Lawyer
When getting legal help or consulting a lawyer, expect to pay between $200 and $400 per hour for an initial in-person consultation. Keep legal consultation costs down by collecting all relevant documents before you meet, including:
- the company handbook
- notes and memos that reflect company policy
- Any evidence of your employment record
Shop for an attorney and a fee deal you're comfortable with and have the attorney review the fine print of any deal you've been offered. Houston employment lawyer Margaret A. Harris HRS says she is seeing more extraneous and harmful provisions in initial offers these days, such as cutting off pending claims under the company's health insurance plan or prohibiting a job loser from ever applying to work at the company again.
Discuss with the attorney whether you have a potential legal claim, say, for discrimination based on race, age, disability, or sex, or illegal retaliation because you refused to do something improperly. Even if you do have a discrimination claim, think twice about suing—lawsuits drag on and aren't good for your mental health or future employment prospects.
When negotiating, it's often better to keep the lawyer behind the scenes—both to avoid a big bill and to keep those who might advocate for you within the company on your side. If you choose to have a lawyer negotiate, one common arrangement is a flat fee (say $400) plus a "contingency"—the lawyer might get a third to a half of what he or she can gain, above what you were originally offered.
A woman in her 50s who was laid off as an executive of a large entertainment company while she was ill reports one attorney suggested leaking her plight to a gossip columnist.
Instead, the woman (who asked not to be named), chose a more discreet firm that had represented other employees in disputes with the company. She paid the firm a substantial $10,000 flat fee but only a tiny contingency. After months of all the back-and-forth, she ended up with a package worth $500,000, twice what she had originally been offered, and her legal bill was only $17,000. Money well spent, says the woman.
Unused Options and Benefits
Ask to keep unvested interests you may have—such as company matches to a 401(k) plan, deferred compensation, and stock options or stock. Five years ago, as part of severance negotiations on behalf of a client at a high-tech firm, San Francisco lawyer Cliff Palefsky insisted on an extra month of stock vesting.
If a bonus is part of your compensation package, ask for a prorated share for the year in which you were terminated. If you've got an outstanding loan from your 401(k), make arrangements to pay it back, or the company might automatically treat it as a distribution subject to taxes and possibly an early withdrawal penalty, too. If you've got unused dollars in a medical flexible savings account, use them up with a quick trip to the dentist or new pair of eyeglasses; otherwise, you'll forfeit them.
Protect Your Freedom to Earn a Living
Non-solicitation agreements, which can prevent you from recruiting prior colleagues as well as clients, are sometimes so broad that you can't even call former customers, let alone encourage them to follow you to a new company.
You may have already signed a covenant not to compete or a non-solicitation agreement as part of an initial contract or in return for a promotion, bonus, or stock options. If you haven't and are asked to sign one in return for severance, see if you (or a lawyer) can narrow the restrictions. (You might also try some negotiating to loosen restrictions you've previously signed.)
A noncompete may be even more onerous because, depending on the wording, it can stop you from working for another firm or starting your own business. California disallows non-competes altogether, though some state legislatures and courts vary in how onerous a non-compete they allow or enforce. To narrow a non-compete clause in your original contract, ask your former employer to list specific companies, services, or off-limits products, or to shorten the time or geographic restrictions in it.
Another increasingly common trap is a non-disparagement clause, which prevents you from saying anything negative about the company, even if it's true. If you're job hunting and want to explain why you're no longer an employee at a company, a non-disparagement clause could prevent you from saying something like, "My boss never had a woman vice president. I complained about the lack of diversity and I was laid off."
It's one thing to agree not to sue in exchange for severance; it's another to consent to provisions that could interfere with your ability to earn a living. If all you're offered is a few months' pays, says San Francisco lawyer Cliff Palefsky, you may be better off walking away from a deal that includes such restrictions. "The real money is in the future,'' he notes.
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