Management

Severance Pay – Everything You Need to Know in 2021

Are you automatically entitled to severance pay when you get fired/laid off? Is it mandatory for employers to offer severance packages? How is severance pay calculated? Find the answer to all these questions and more, right here.

Almost everyone gets fired or laid off at some point in life as an employee. While it can be quite traumatic, you can always find a silver lining or two in being asked to leave a firm. A severance package is one of them, provided your employer offers one. 

If you are facing the prospect of termination/layoffs, you probably have at least a few questions about severance pay. Unfortunately, unless it is part of your employment contract, a severance package is not guaranteed. Here is a quick guide to everything you need to know on this topic:

What is Severance Pay? 

Severance pay is a type of compensation provided by employers to an employee who has been asked to leave their employment. There are three common situations in which severance pay can be provided: 

  • Lay-offs
  • Dismissal or termination of employment
  • Resignation, retirement, or other instances involving a mutual agreement between employer and employee

In its simplest form, a severance package is given as a cash payment, either in lump sum or instalments. It can also include other benefits, like health insurance, accrued pay for sick days, assistance in finding another job, continued access to company equipment/devices, stock options, and more. 

In almost all instances, an employee accepting a severance package will be asked to sign a “separation agreement.“ It will contain some or all of the following clauses: 

  • A waiver that protects the employer from future lawsuits
  • A non-disclosure clause
  • A non-compete clause

Are Employers Required to Pay Severance? 

In the United States, Fair Labor Standards Act (FLSA) does not mention severance pay. So, under federal laws, it is not mandatory for employers to offer severance packages to terminated employees. Some states like Puerto Rico do have laws that entitle employees to severance pay. 

Another major exception would be the WARN Act – employers who fail to provide advance notification about mass lay-offs involving more than 100 employees are legally required to offer compensation that is comparable to a severance package. 

But in other circumstances, most employers offer severance pay as a gesture of goodwill, and as a way to maintain a positive reputation. Linking it to a severance package also allows the company to protect its interests against future losses due to lawsuits or other actions by an employee. 

Severance packages may also be provided based on agreements between employers and unions. It is also legally binding if it is part of the employment contract. 

How is Severance Pay Calculated? 

The monetary part of a severance package is calculated on the basis of your employment duration at the company. The standard severance pay is usually one- or two weeks’ worth of wages, paid for every year of employment at the company. 

But this is not fixed – the important thing to note is that all aspects of a severance package are negotiable in most instances. It depends on these important factors:

  • The total years of service
  • The seniority of the employee
  • Size of the company and its current health
  • The stated company policy on severance

Lower-grade workers can negotiate to increase the number of weeks. Four weeks of pay for each year is considered ideal, but this is usually attainable for employees who have stayed with the company for a long time. 

 Another consideration is your seniority, and whether you are part of the management. In the case of middle managers and other senior executives, a month’s salary for each year worked is the norm. But higher-level executives and CEOs can get bigger packages

How to Negotiate a Severance Package

If you face the prospect of impending dismissal, take some time to research and plan the following things: 

  • The company’s severance policy 
  • Past severance payments to former colleagues
  • Your own financial needs and other important benefits you want to keep
  • How long it may take you to find another job

Knowledge of these things will boost your case when you are involved in any negotiation with the company. Even if you are laid off at short notice, you can take some time out to think things through, read the employee handbook and research the factors listed above. 

There is no need to sign any severance agreement immediately, even if your employers try to press you. In most cases, employees have a 21-day window to accept a severance agreement. Take the time to review the agreement. Consider hiring an employment law attorney in case: 

  • You are a victim of discrimination
  • The agreement is not easy to understand
  • The agreement is too long and complex

While there is some leeway for negotiations, it is entirely situational and dependent on the amount of leverage you have on your employer. In case of termination, this may be minimal when it involves non-performance or misconduct, for example. 

But in general, you can try to negotiate for the inclusion of the following benefits in your severance package: 

  • Payment of health insurance/life insurance coverage premiums until you find a new job, or for a few months at least (on top of COBRA benefits
  • Anything from your retirement benefits or other stock plans (depends on state laws and employer policies)
  • A recommendation letter/referral letter for future employers, as well as documents highlighting your achievements,  
  • Retraining or provision for outplacement assistance and other services
  • Other company perks, like the continued use of laptops/devices, company car, etc. 

Do You Have to Pay Taxes on Severance Pay? 

Under the Federal Income Contributions Act (FICA) both employers and employees have to pay taxes on severance pay benefits. The US Supreme Court had the final word on this question back in 2013. You will have to pay the Federal Income Tax and Medicare and Social Security tax as an employee. 

The rate of taxation is not very different from other forms of compensation. Usually, it is taxed at the same rate as your regular paycheck. However, if you receive a huge amount as lump sum payment, the tax rates may increase. 

Does Severance Pay Affect Unemployment Benefits? 

A lot will depend on your state’s unemployment benefit rules. But a general rule of thumb is that if you are still receiving severance pay, you cannot claim unemployment benefits. The logic is that you are still on the company’s payroll in this period. 

The same rule may apply in the case of lump-sum payments as well. For example, if you receive three months wages as a lump sum severance package, you cannot receive unemployment benefits until the end of those three months.

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