How does severance pay work

January 08, 2023  •  Reading Time: 8 min.

Does your company pay severance? All you need to know about a fair severance package

If you are terminated from your job, one of your first concerns is probably whether you will be offered severance pay.

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Yes, your employer may offer you severance payment. Separation pay can be in the form of a lump sum, continuation of salary, or some other form of payment. You should be aware that employers are not required to offer severance packages. However, if they do, this article will inform you of the exact policies and procedures for obtaining an appropriate severance package.

What is severance pay?

Severance pay is usually a one-time payment from the employer to the employee. It is a remuneration for the fact that the employee loses their job and does not receive any further salary as a consequence. Severance packages typically include compensation up to the termination date, all unused vacation time, unreimbursed business expenses, and an additional lump sum payment.

ℹ️ If employees leave a company, they can negotiate certain benefits with their employers, just as they did before they were hired with their employment contract.

This means you can negotiate a severance package and receive severance as a result. Employees typically have 21 days to do so. During this time, you should think about and also do some research on what is common in your industry or find out about the company’s severance policy. If you are not sure about the eligibility requirements, it is best to seek legal advice.

You can then negotiate the following points for your severance agreement:

  • The amount of the severance payment.
  • The type of severance payment.
  • The health care coverage. (ℹ️ Whether your former employer can cover your health insurance until you find a new job. This often depends on individual state laws and the size of the company).
  • The vesting of pension plans or stock options.
  • Certain outplacement or vocational training benefits.

Above all, you should seek continuation of insurance benefits and assistance in finding a new job, and other forms of support. Often, your advantage in such negotiations is that most companies do not want you to badmouth them or even pursue legal action. Therefore, you can often negotiate more severance pay and severance benefits than you might think.

When are you eligible for severance compensation?

Your employer is most likely not legally required to pay you severance. Under the Fair Labor Standards Act (FLSA), a company is only responsible to pay your salary – until your last day of work.

That said, there are exceptions:

  • For example, if you were hired under a collective bargaining agreement, certain employment contracts may stipulate severance pay.
  • Another reason are mass layoffs: If your employment was terminated in a mass layoff, you may be covered by the Worker Adjustment and Retraining Act. Under this law, employers with more than 100 employees are required to notify their employees 60 days in advance of a mass layoff or group reduction. If a company fails to provide this required notice, it must pay workers severance pay of up to 60 days’ wages after their job loss.
  • In addition, there are often certain internal company policies and this written policy may state that the employer will offer you a severance package to ensure a smooth transition – both for the company and for you. If you find yourself in this situation, you can most likely negotiate a fair and mutually satisfactory package.

How does severance pay affect unemployment benefits?

Whether a severance package affects your unemployment benefit rights depends entirely on the laws of your state. In some states, you cannot claim unemployment assistance during the time you receive a severance package. Even if you receive your severance package as a lump sum payment, the Department of Labor often sets a specific time limit before you can claim unemployment payments.

To find out if this is the case in your state, it’s best to check with your state’s employment office. This will help you determine the extent to which a severance payment will affect your entitlement to unemployment benefits.

How do you calculate severance pay?

There is no set formula, but severance packages are often based on the length of employment. It can therefore be, for example, a week’s pay for each year of employment. Typically, the calculation is also based on the position the employee held.

Is severance pay taxable?

Any severance package must be taxed. Also, all additional pay you receive, e.g., for unused vacation time, is taxable. A lump sum payment is also subject to tax, and the employer may withhold a higher rate than usual if it puts you in a higher tax bracket. Therefore, you should consider deferring part of the payment to the next calendar year so that no larger amount will be withheld.

4 Steps to an appropriate severance package

If all of this seems somewhat complicated, and you are still not sure if you are eligible under the law or what you will end up getting paid, we have created a guide on how to negotiate a good severance package:

1. Plan your severance pay in time

You would quit in the near future anyway? Plan wisely, because if you hold out until your employer gives you notice, you can apply for unemployment perks and receive severance pay. It’s best to make a list of the key benefits you want to negotiate in advance. Also, inquire about the company’s severance policy and find out what former colleagues have been paid.

2. Take time to review any severance package offers

The employer has terminated your employment and wants to offer severance packages immediately? Do not feel under any pressure to sign the contract straight away. Take a certain period (you have 21 days) to read the document carefully and then consider it.

3. Find out more about severance payments in your state or city

After an initial review of the agreement, you can consult an employment law attorney, especially if the wording in the severance agreement is too complicated. Check with your lawyer to find out what laws apply in your state and whether there are any special provisions – for example, about the amount of payments. Also contact an employment agency to find out how long it might take to find a new job with the same level and salary.

4. Negotiate favorable conditions

Now it’s time to negotiate a fair payment and further benefits:

  • Severance pay

The severance pay offered is typically one week’s pay for each year of employment – but may be higher. If losing your job is an economic hardship, you may receive up to four weeks of severance pay for each year of work. Senior or executive employees frequently receive an even larger amount.

  • Insurance coverage

Try to extend your health, life and disability insurance coverage. The Consolidated Omnibus Budget Reconciliation Act (COBRA) allows you to continue your insurance coverage for a time period of at least 18 months. Also inquire whether your employer can cover the cost of your health insurance until you find a new position. The company may also be able to cover your life and disability insurance during this period.

  • Pension plans and stocks

What happens to your pension and stock plans varies from state to state and employer to employer. It’s best to check the U.S. Department of Labor guidelines or talk to your attorney about them.

  • Company benefits

Find out if you are allowed to keep company property and have your employer confirm this in writing. Other perks to consider include extending the use of your company car.

  • Unemployment insurance

If you have lost your job at no fault of your own, the Federal-State Unemployment Compensation Program provides financial assistance to unemployed workers.

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Many employers offer their employees a termination agreement, which regulates all financial aspects of an employee’s separation from the company after termination of the employment relationship. Although such severance agreements are not required by law, employers may offer them as a gesture of goodwill – or even to maintain their competitiveness. A conventional severance agreement provides one to two weeks’ salary for each year of employment in one lump sum. As an individual employee, you typically have 21 days to sign the separation agreement and can also revoke it within 7 days.

Frequently asked questions about serverance pay

Why do companies offer severance pay?

A company may offer severance pay to show the employee goodwill after termination and also to reward the employee’s performance.

Is severance pay being paid out in a lump sum?

Severance pay may be provided in the form of a lump sum, salary continuation, or some other form of remuneration.

How do severance pay and vacation pay affect unemployment?

When workers receive ongoing vacation pay from their former employer while they are unemployed, these payments often result in a reduction in their unemployment payments.

When should you reject a severance payment?

If the severance pay is linked to conditions that are onerous for you, such as a ban on working for another company in your field for a set period, you can also reject the severance pay. In general, you should always consider a severance offer carefully before accepting it.

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