The Employer Guide to Severance Pay

The Employer Guide to Severance Pay

When you bring an employment relationship to an end, most employees expect to get a form of compensation in return. Whatever the reason for the employment termination might be, employees want to know if they can count on this benefit in case they lose their jobs unexpectedly. That is to say, they expect severance pay.

There are many reasons to put an end to an employment relationship. This can range from poor performance or absenteeism to more serious reasons such as inappropriate conduct or drug and alcohol abuse at work.

Employees getting fired statistics

According to a CareerBuilder study, 22% of employers have fired an employee for calling-in-sick with a fake excuse, and 24% have fired an employee for using the internet for non-work related purposes.

Although firing an employee can have a negative impact on employee turnover rates, keeping an unproductive employee in the company can affect productivity in the long term.

Therefore, letting an employee go can be the best course of action in certain situations. The question is: is severance pay a law requirement? Can you not offer severance pay? If so, what are the implications?

Let’s take a look at what severance pay is in the first place:

What Is Severance Pay?

Severance pay is a form of compensation that a company offers employees upon their employment termination. In other words, the employer offers the worker a benefits package when they decide to discharge the employee from the company.

Which Employees Receive Severance Pay?

Most times, employees who get this benefit are those whose contracts were terminated due to downsizing, firing, or even employees who are soon retiring. Employees who resign don’t get that benefit in most cases, but there are some instances in which they might receive this compensation.

The fact is that you, as an employer, can decide who receives the benefit and who doesn’t. It all depends on your company’s policies.

Is Severance Pay Required by Law?

Companies have the legal obligation of giving employees this benefit if any of these two circumstances happened:

1. If the Employment Contract Stipulates It

If the original employment contract includes a clause referring to severance pay, the employer will have the legal obligation to give the employee this compensation. This will only apply if the reason for the employee’s discharge is included in the severance pay conditions clause.

2. If There Was a Verbal Agreement

Even if there wasn’t a written agreement in the employment contract, a verbal promise of severance pay is enough to make this a legal obligation.

Apart from that, there isn’t a specific law that requires companies to offer severance pay to employees, according to the U.S Department of Labor.

Although employers are not required to give the severance pay per se, the Fair Labor Standards Act (FLSA) establishes that employers have to pay accrued vacation time to employees upon their employment termination.

How Is Severance Pay Calculated?

When a company decides to offer this benefit to its employees, they calculate the payment based on different factors.

Since there isn’t a specific law that dictates the factors to take into consideration, companies often decide to include factors such as:

  • Wages
  • Insurance benefits
  • Unclaimed employee benefits
  • Recommendation letter
  • Equipment (such as laptops)
  • Accrued vacation and sick days
  • Length of service

Moreover, an AON study found that most companies (55%) calculate employees’ severance pay based on salaries only. Just a few companies calculate it using salaries and other benefits.

How You Should Offer This Benefit

There are two ways you can use to give former employees severance pay. The first option is to calculate the total amount. The second option is to pay a lump sum or pay the full amount in regular installments.

Depending on the employee’s length of service, the amount to pay can be difficult to bear for the company in a single upfront amount. In this case, paying the employee in installments can be a better way to deal with it.

Is It Taxable?

In the U.S, severance pay is taxable. This includes federal, state, and local taxes. In addition, payroll taxes include social security tax, Medicare tax, and federal income tax (FUTA).

For more information, read Publication 15 (Circular E) on the Employer’s Tax Guide.

Severance Pay Statistics

These statistics will show you how companies in the U.S. manage severance pay policies, according to AON:

1. 75% of companies have an involuntary severance policy. This represents 4% more companies than in 2014.

2. Some companies use job level whereas others use tenure to determine severance pay:

3. 61% of companies have a cap for the number of severance pay weeks they offer.

4. Severance pay policies based on job level offer the best benefits to VPs.

Implications of Not Offering Severance Pay

Even though offering this is not legally required in the U.S, not offering your employees this benefit can have negative implications on your organization.

Giving severance pay only to some specific employees can make your organization look discriminatory. If you are to offer the policy, be consistent with it.

An example of this is the announcement SEARS made of discharging all hourly-paid employees with no severance pay. Meanwhile, they would give annual bonuses to executives when they were restructuring in bankruptcy. This provoked negative criticism from employees and the public in general.

Also, not providing severance pay can make candidates think twice before accepting a job at your organization.

What Is Voluntary Severance Pay?

Voluntary severance pay refers to a special benefits package employers can offer an employee in hopes they’ll resign voluntarily. Unlike direct employment termination, employees have the option of turning down this offer.

This option is often offered to employees when it benefits the company by reducing the costs of wages and perks. Employers tend to offer this to employees who are close to retirement.

Another reason employers might offer this option is to prevent possible layoffs due to downsizing. Voluntary severance packages are often a great deal for the employee, so the majority of times they will prefer to accept them.

Should I Offer Severance Pay?

Since most companies offer severance pay in the U.S, not doing so would make your company fall behind. This benefit is a way to provide your employees with positive employee experience, which is a key factor to keep employee turnover rates low.

Also, severance pay offers employees the possibility to cope with unemployment. This benefit can make a big difference for employees when they transition from one job to another.

Therefore, offering severance pay is a way of recognizing your employees after they leave the organization. In many cases, they have been working with you for years and some of them for even decades.

Compensate them well.