Severance Package: The Basics

A severance package is defined as compensation provided by an employer to provide for an employee who is ending their service with the company. There are a number of circumstances that may warrant such pay, including job elimination, layoffs, or any reason that the employee leaves due to mutual agreement. 

Receiving severance pay depends on whether the employee has signed a severance agreement, and the amount given as part of this package is generally based on how long the employee has worked for the employer. It may consist of unused paid time off (PTO) such as vacation or sick time, as well as payment of any business expenses that haven't yet been reimbursed.

Under normal circumstances, severance pay consists of one or two weeks' worth of pay per year of service the employee had under the company. If the employee was in an executive position, it may constitute a month or more pay per year of service.

Alternately, it will consist of whatever the contract specifies. In such cases it can comprise almost any amount of money, extended benefits and even future job placement assistance.

Who Is Eligible to Receive Severance Pay?

Employers are not required to provide severance pay under the law. Many choose to provide it to those employees who are laid off or terminated, however. The Worker Adjustment and Training Notification act (WARN) provides some protection for employees who are facing layoffs.

Under the WARN act, businesses with over 100 staff who are preparing for major layoffs are required to provide 60 days of notice of the closure of the company or any large department. Failure to give this notice entitles employees to severance pay. Employees who are fired without notice may be eligible for severance pay, but this is considered a highly discretionary situation. 

Breaking Down "Severance Package"

A company's employee handbook should provide information related to any severance package policy the company maintains. Keep in mind, however, that severance packages are negotiable and the handbook may be outdated. Companies aren't required by law to offer such packages, and may choose to end such a policy, especially if layoffs are related to financial difficulty. Also note that if an employee accepts a severance package, he may forfeit his rights to collect unemployment or to file a lawsuit for wrongful termination. 

Things to Know about Severance Packages

There is a difference between a last paycheck and a severance package. A last paycheck covers the time the employee worked up to his termination date and may include payouts due for accrued paid time off, as well as any deductions for benefit elections and statutory reasons. If company policy allows, the employee may be eligible to receive sick-leave payouts or other bonuses.

A severance agreement, on the other hand, contains an outline of the severance pay and various benefits that the employer might opt to provide beyond a standard last payment. This is considered a severance package.

In terms of layoffs, an employer is required to establish a justifiable and documented reason for enacting layouts and how they'll affect protected worker classes. They may then agree on a severance formula to deliver fair and equitable packages to laid-off employees. This formula will generally be spelled out in the employee's severance agreement, which may include terms of pay, benefits information, property return, non-competition clauses, confidentiality agreements, a covenant not to sue, as well as a range of other requirements and restrictions.

The monetary components of a given severance package can include a variety of compensatory payments, including service-based pay, commissions, bonus payments, pension rights, profit sharing and stock options, loan repayment terms, business expenses, and more.

Those employees who are terminated because of job elimination are usually still eligible for unemployment compensation. Most agreements don't include important information on applying for unemployment, but in most states, the employee can't collect unemployment while collecting severance pay. He should check with the unemployment agency in his state for specifics.

Non-competition clauses are often the biggest hurdles for severance agreements. Most companies require these clauses as part of their employment offer. Make sure the agreement is fair, and that the employer is willing to narrow its scope accordingly if an employee is laid off. Check three specific areas of the non-compete clause — geographic region, agreement scope, and the duration of time it covers.

People over the age of 40 are considered a protected class. This means that they are covered under the federal Age Discrimination Employment Act (ADEA). This act gives workers over the age of 40 up to three weeks to consider a release form, followed by an additional week during which they can revoke it. In order to remain compliant, employers are required to provide both the age and job title of every employee affected by layoffs and the job titles and ages of those employees who are not being laid off. 

70 percent of companies in the United States engage outsourced job placement services to help those who have been laid off to find new jobs. These services offer help in areas such as resume creation, preparation for job interviews, conducting job searches by target keywords, networking, and general office services.

Individuals who are transitioning to new positions should look into current company policies on recommendations, removal of personal files, and continued use of company email and voicemail. Some employers may be willing to allow flexibility for a short period during the job search. Don't underestimate the power of networking. Over 60 percent of job seekers find employment through somebody they know. 

What Is an Employer Required to Pay?

There are no laws requiring employers to pay severance packages at all. The only laws in place under the Fair Labor Standards Act require that employers pay the employee their normal wage through the completion date of their time with the company, as well as for any paid time off that the employee has accrued up to that time, including vacation time but excluding sick time.

As such, any severance pay the employee receives is completely based on the employer's goodwill, unless there is an employment contract, handbook, or another official written source guaranteeing severance pay. If an employee does not receive severance pay, any lump sum is taxable as regular income, and the employer may withhold taxes as standard.

They may also withhold taxes at a higher rate if the payment will adjust the employee's tax bracket. An employee can, in such cases, request to defer part of the severance to the next calendar year to avoid this. In most states, however, it may be better to accept a single lump sum because of the way unemployment is handled.

Lump sum payments deliver the full amount of the severance at one time. It gives an employee immediate access to the funds that will be paid to him, allowing him to invest them or otherwise use them as he sees fit. At this point, any other benefits an employee gets will cease as well. If, on the other hand, he accepts weekly payments over time, his unemployment compensation will be lowered every week as long as he is still receiving severance pay.

Negotiation and Severance Pay

If an employee is laid off, he can attempt to negotiate higher levels of compensation than were initially offered in the severance package. If he chooses to do so, however, it means that he has legally refused the offer of severance, and at that point, the employer can legally refuse to pay severance altogether. This is why it is advisable for employers to have employees sign release forms that clearly state that the offer is non-negotiable.

Not only does such a form avoid disputes, it helps to avoid the appearance of an employer playing favorites or engaging in discrimination against protected classes of workers by keeping everything equitable and fair across the board. Negotiations generally occur when there is no pre-existing policy and no precedent exists, particularly if the situation involves only a single employee.

Salary Continuation

Salary continuation means that the employer agrees to keep an employee on their payroll for a given stated period of time, and he will continue to receive paychecks just as if he was still working for the company. He will also receive health insurance and other benefits as though he was still employed with the company, and he can ask for a specific period of continuation, or request continuation until he finds new employment. 

Benefits that may be continued include life insurance, continued use of company property like laptops, cell phones, mobile devices, or vehicles, as well as disability coverage. Usually, an employee cannot receive unemployment while he is getting continued salary and benefits. This is an excellent method of severance because the employee still receives regular payments during the period of continuance.

After an agreement on continuation is reached, payroll personnel will handle the continued issuance of checks; the person that authorized the continuation is now removed from the picture. There can, however, be room for error, especially if the period of continuance is over a long term. It's also not uncommon to get payments late or have them missed altogether. 

Unused Vacation and Sick Pay as Severance

Despite common wisdom on the issue, there are very few states that have laws guaranteeing payout of unused sick time or vacation time when they leave their jobs. Most companies have a policy that allows payment of unused leave, but these generally make a difference between those employees who voluntarily leave, those who get laid off, and those who are dismissed for reasons of misconduct. 

If the company does have such a policy and the employee is accused of misconduct, the employee may have to negotiate for payout of unused PTO, or file a lawsuit for breach of contract. It's usually not worth such a lawsuit unless the unpaid leave represents a very substantial amount of compensation. 

Require a Release From All Claims in Return for Severance Pay

It is generally recommended that employers require employees to sign release forms that indemnify the company from lawsuits in the future. If there is no severance pay offered, there's no reason for an employee to sign such a form, however.

Such release forms are increasingly common and recommended for employees over the age of 40 to release the employer from the risk of age-discrimination claims. It also requires adherence to any timeline required in that company's state. For example, in Michigan, an employee has three weeks to decide about signing off on the release and accepting severance. After signing, the employee then has another week to change their mind and renege.

There are no state or federal laws guaranteeing severance pay. It's something that's offered solely by the discretion of the employer, but may be guaranteed in an employment contract or written company policy. In the end, it serves two purposes. The first is to display goodwill on the part of the employer. The second is to protect against lawsuits by offering a consolation for dismissal or layoffs, and by requiring a release form protecting the employer from these. 

In severance packages, the employee leaving the company receives pay that is intended to supplement unemployment compensation and provide a cushion to allow them to protect their standard of living as they seek new employment. It's a supportive gesture to protect employees who are terminated through no fault of their own. It's also a good way to increase goodwill among employees still on the payroll, as they view the employer in a positive light.

If you need help with severance packages, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.