What Is Severance Pay and How Does It Help?

Severance pay is compensation that an employer may dispense to a laid-off employee. It can provide financial assistance to staff leaving their job. In this blog, we'll explore what severance pay means and familiarize you with some key terms.

With more and more companies investing in employee welfare, an important question that arises is how should employers provide severance packages for their staff.

As an employer, severance pay is something that a company needs to think about. The practice needs to then be put into writing in conjunction with the company’s legal obligations. After all, there are legal requirements when it comes to the termination of employment. Many of the laws are also country-specific.

In general, a well-thought-out severance pay plan that complies with employment law enables employees to leave on the best possible terms and with helpful support. The way in which severance plays out can also be reflective of a company's culture.

Ultimately, if done right, the way in which a company goes about severance may prove beneficial for both parties involved. Severance pay that is communicated well and gives employees input makes transitions smoother while helping build loyalty between the employer and worker alike. It can also help improve morale within organizations, with staff knowing that there is a safety net when difficult working circumstances have to be navigated.

But first, let’s take a look at what severance payment means.

What Is Severance Pay?

Severance pay is financial assistance or compensation given to a former employee who has been laid off from their job or had their employment contract ended earlier than expected. The layoff or change in employment status may be due to restructuring or reorganization that is outside of their control.

As a payment, severance is often either a lump sum or paid over a period of time to soften the landing for a person leaving their position. It offers those affected during times of job transition some security and peace of mind knowing that there will be some level of continuous income in the coming weeks or months. It’s important to note that severance pay can apply to a number of end-of-work or contract termination circumstances.

Severance pay calculation usually depends on a company’s legal obligations. Certain circumstances require employers to pay terminated employees a specific number of weeks’ pay. A number of deductibles may also be taken from the total, including any advanced holidays or paid time off that has been taken.

In many non-legal cases, the severance agreement is based on negotiation between the worker and the employer. For example, as you will see below, some countries leave severance pay or unemployment compensation largely up to the parties involved. This can lead to employees having to negotiate severance packages and the amount of severance pay during the recruitment process.

Severance Pay vs Redundancy Pay

There can be some confusion over severance and redundancy payments. Redundancy pay is actually a type of severance pay, one that is typically governed by statutory entitlements resulting in a guaranteed number of weeks of pay. A redundancy payment occurs when an employee’s position has been eliminated or is no longer required. This could be for reasons related to the business downsizing or ceasing operations in certain areas.

In many countries, statutory redundancy payment is related to the amount of time you have worked at a company. For example, in the United Kingdom, statutory redundancy pay is one week’s pay for each full year of service you have worked between the ages of 22 and 41. For those under 22 and over the age of 41, the payment entitlement is different. You must have worked for two years or more to apply for statutory redundancy.

In contrast, in the USA, there are no mandatory or federal laws governing weeks of severance or severance pay. Under the Fair Labor Standards Act (FLSA), there is no requirement for severance pay. According to the US Department of Labor, severance pay is “a matter of agreement between an employer and an employee”. For this reason, some workers in the US are advised to ask about a company’s severance policy or review their employee handbook before signing their contract.

There are some other safeguards in the US, however. Under the Worker Adjustment and Retraining Notification Act, employers with 100 members of staff or more must give people at least 60 days’ notice of layoffs or face having to provide severance pay. There is also the possibility of Cobra coverage, which provides support to people who have lost health benefits associated with their job.

Cobra: The Consolidated Omnibus Budget Reconciliation Act provides a safety net for those in times of financial hardship by offering protection against loss of employer-sponsored health care and other benefits.

Other reasons for severance pay outside of redundancy could include retirement, injury, the early end of a contract, gardening leave, or as a token of appreciation. Severance is typically offered as part of an agreement signed upon termination.

Severance pay can sometimes be used by companies to motivate people to agree to employment termination. For example, facing difficult cost-cutting decisions, some employers will offer employees the option of voluntary severance pay – a mutually agreed upon financial incentive for leaving their position. This differs from redundancy pay, which is largely imposed on specific staff members rather than being offered as an available choice.

What Is the Goal of Severance Pay?

Severance pay can provide helpful relief during a difficult time, though it is important for employees to understand that not every end-of-work situation will involve a payment. Outside of legal parameters, when an employer offers severance pay, it's often as a gesture of appreciation for the person's hard work and dedication to their role. It provides comfort that they will be taken care of during times when job security is uncertain.

These days, companies that provide good severance packages are likely to be businesses that are dedicated to improving the employee experience and creating a positive atmosphere. Remember, offboarding is just as important as onboarding to a company’s reputation.

Severance Package Explained

Severance pay can be part of a package that also includes life insurance benefits, health care,  stock options, health insurance, retirement plan, outplacement services, and other non-financial perks.

A severance package can be the difference in affording a worker security, stability, and autonomy during an often stressful career transition. Knowing what to look for when evaluating this type of agreement is paramount to getting the most out of any given offer. Below are some key terms to familiarize yourself with.

Severance Keywords

Severance Notice: If you are terminated from a job, typically the employer has to provide you with advanced notice before your last day of work. This period of time is known as ‘severance notice’, and it allows employees to wrap up any unfinished business or organize their search for a new job.

Termination Meeting: A job termination meeting is an important but often difficult conversation, where employers and employees discuss the end of a full-time professional relationship. The outcome could have lasting implications for both parties involved – which makes it vital to approach this situation with sensitivity and respect. It usually requires the input of management and the human resources team.

Unemployment Benefits: Unemployment benefits are a form of financial assistance that provides much-needed relief to those out of work. They give unemployed workers the means to pay bills and support themselves and their families. Severance pay may impact the ability to receive unemployment assistance depending on the country in which you reside. So it is important to double-check your entitlements, tax bracket, and social security benefits if your employers offer severance pay.

Outplacement: Outplacement is a human resources service focused on assisting displaced employees during periods of change. It can offer a range of services, such as career counseling and full-time job search support, to help those affected by layoffs. Basically, it helps people readjust quickly to a new employment circumstance. Outplacement should provide compassionate guidance so individuals can get back into an evolving job market with strength, confidence, and resilience.

Stock Options: When employment comes to a close, offering stock options in severance can act as a parting gift to celebrate an employee’s service. Sometimes offered as part of a severance package, stock options can be a bridge between past success and future triumphs. The option can give departing workers the chance to reap rewards even after they have left their job.

Annuity: Severance packages can offer more than just a lump sum. Some employers may include an annuity as part of their severance package, allowing employees to secure future income in retirement or after leaving the job.

Unemployment Insurance: A job loss can be challenging, but unemployment insurance is a resource for those who need it to stay afloat and get back on their feet. It provides an essential safety net that helps keep families and individuals secure during difficult times.

Confidentiality Clause: When a job relationship comes to an end, one important detail to consider is the confidentiality clause in severance agreements. Such a legally binding document can serve as an acknowledgment that both parties will uphold the confidentiality of information and practices shared during their working experience. If such a clause is required in your severance package, it is important to seek legal advice or contact a law firm so that both parties know about their obligations and rights.

To sum up, severance pay is certainly a difficult topic to broach and it’s not something that many people want to have to consider. But when all the above factors are considered and the process is carried out respectfully, everyone should feel confident that a fair and positive conclusion can be made for people on both sides.

For more HR explainer articles, check out our other blog topics here.

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