What is Severance Pay?

Understanding Severance Pay Meaning

There is no explicit definition under any laws regarding severance pay. It is generally understood as employee compensation, financial or otherwise, after their employment has ended. 

Moreover, severance pay meaning can vary depending on specific circumstances and agreements with your employee. 

To define severance pay, you may consider it a one-time payment or a series of payments made as a goodwill gesture, as part of an employment contract, or as a legal requirement. 

It may include additional benefits like health insurance continuation, career counseling, or unpaid vacation payouts.

Primary purpose of severance pay 

Severance payments provide employees with a financial cushion when transitioning to new jobs. By using common severance packages, you can avoid disputes and ensure smoother exits. 

Situations where severance pay might apply

• When you lay off employees due to economic downturns, reduced budgets, or downsizing efforts.
• Organizational restructuring leads to redundancy in certain roles or departments.
• When you merge or acquire companies, job roles overlap, leading to the termination of some jobs. 
• Sometimes, severance is part of negotiated exit terms between you and your employee. 

Employment contracts, company policies, or country/region-specific labor laws often govern severance pay laws.

Why Do Companies Offer Severance?

Global expansion is riddled with HR challenges, from legal compliance to retaining top talents. Here’s why severance pay is required: 

Legal compliance:

• Specific laws, such as the Worker Adjustment and Retraining Notification (WARN) Act in the United States, enforce severance pay during mass layoffs.
• Moreover, you must comply with specific severance provisions in employment contracts, collective bargaining agreements, or company policies.

Fostering goodwill:

• Offering severance pay, even during challenging times, can reduce the likelihood of disputes and preserve your reputation. 
• Moreover, several IT companies used common severance packages to retain top talents during the recent pandemic. 

Encouraging confidentiality or non-compete compliance:

• You can leverage severance pay agreements tied to clauses requiring employees to maintain confidentiality, waive legal claims, or agree to non-compete terms.

Benefits of offering severance

For employers

• You can enhance your company’s reputation and retain top talent with attractive severance packages. 
• Severance pay packages serve as a tool for ethical workforce management. 
• It may reflect positively on investors and customers knowing that you treat your employees well during downsizing. 
• It compensates for job loss, mitigating the risk of wrongful termination claims.

Benefits for employees

• Severance helps employees manage their finances while seeking new employment or retraining. It may increase their chances of finding new employment quickly.
• It can boost morale among remaining employees.

Moreover, the promise of severance pay makes employees feel that their service is valued.

Are Companies Required by Law to Offer Severance Pay?

There can not be a single answer to: are severance packages required? Or do companies have to pay severance?

Moreover, negotiating severance pay for remote employees is still evolving and it would depend on region-specific labor regulations for remote workers. 

But if you are looking for a definite answer to whether severance pay is mandatory - 

• The Fair Labor Standards Act (FLSA) in the United States does not impose any severance pay federal mandate. 
• However, under the WARN Act, failure to provide 60 days’ notice for mass layoffs or plant closures could result in payment of wages and benefits for the notice period.

• In most EU countries, severance payments are made in lump sums based on years of service and minimum wage standards:

Common Severance Packages

A common severance package is a set of employee benefits, typically offered upon termination of employment. While the specific components can vary widely, here are some of the most common elements:

Determining Severance Pay: Industry Standards

You cannot adopt a one-size-fits-all approach in determining severance pay. However, you can refer to the following industry standards for severance pay: 

General standards for severance pay:

A common practice is to offer one to two weeks of pay for each year of service. However, this can vary significantly based on factors such as job position and employee seniority, company performance, industry norms, and economic conditions. 

Moreover, you can determine severance pay when terminated for performance based on the employment contract.

Rule of 70 for severance:

Using the "Rule of 70", you can determine if an employee is eligible for retirement-related. You can formulate “Rule of 70” in your severance pay policy if two conditions are met:

1. The employee must have worked for the company or its affiliates for at least 10 years.
2. The employee must be at least 55 years old.

Thus, if the sum of the employee's years of service and age is 70 or more, they meet the Rule of 70 criteria for severance.

Industry-specific variations:

• Technology: The tech industry, particularly in the United States, offers competitive severance packages, often exceeding the standard one to two weeks per year. This is due to high employee turnover. 
• Finance: The financial industry, especially investment banking, often has generous severance packages, especially for senior-level employees.
• Healthcare: Severance packages in healthcare can vary widely depending on the specific role and the organization.‍
• Manufacturing: Manufacturing industries may offer more modest severance packages, particularly for hourly workers.

How is Severance Pay Calculated?

Wondering ‘How much is severance pay?, ‘How are severance packages calculated?’ or, ‘What is severance benefits?’ 

You can calculate severance pay benefits based on factors, including the employee's tenure, job role, minimum wage standards, and specific company policies. 

Here are some common calculation methods:

Fixed number of weeks' pay:

• The most commonly prescribed formula: this method is based on a predetermined number of weeks' pay, regardless of tenure.
• The number of weeks increases with the employee's years of service. For example, one week's pay for each year of service.

Percentage of annual salary:

• A fixed percentage of the employee's annual salary is awarded.
• The percentage increases with the employee's tenure. For example, 1% of the annual salary for each year of service up to a certain limit.

Formula-based calculation:

• More intricate formulas that consider multiple factors like tenure, salary, and performance.
• These formulas can be tailored to specific company policies and industry standards.

Tax Implications of Severance Pay

The most definitive answer to whether severance pay is taxable is yes. 

In the United States, severance payments made to employees are subject to withholding taxes: 

• If severance pay is part of a regular paycheck, the federal severance pay tax rate is based on completed W-4s, state income taxes, Social Security taxes, and Medicare taxes. 
• If severance pay is made in addition to usual pay, a flat withholding pay tax rate of 22% applies.  

Severance pay benefits are taxed even in EU countries. 

Moreover, the tax implications for remote employees remain the same as long as the specific labor law treats them at par with full-time workers. 

Paying taxes on severance packages

1. Determine the taxability of severance pay in your region of operation. 
2. Withhold taxes per regular salary payment for any severance payments unless specifically exempted. 
3. In the United States, you can report severance pay using tax form W-2. 

You can minimize the tax burden associated with severance pay by implementing the following strategies: 

• Spreading out the severance payments over multiple tax years could reduce the overall tax liability. 
• Additionally, offering tax-advantaged benefits like extended health insurance or retirement plan contributions can further mitigate employees' tax impacts.

Negotiating Severance Pay

Your employees will be keen on negotiating severance pay packages as it can impact their financial security and career prospects. It's important to have a clear severance policy outlining eligibility criteria, calculation methods, and any additional benefits. 

Qualifying for severance pay

By having a well-defined policy, you can manage employee expectations, minimize legal risks, and maintain a positive company reputation. You can set up a clause in the employment contract for severance pay eligibility upon termination: 

• Employees affected by company-wide layoffs or restructuring are often eligible for severance pay.
• If a specific department or team is eliminated, the employees within those teams may also qualify for severance.

• Employees terminated due to poor performance or misconduct are usually not eligible for severance pay. 

Other factors influencing eligibility:

• Union contracts may include provisions for severance pay.
• Some jurisdictions have laws that mandate severance pay under certain conditions, such as mass layoffs or plant closures.

Conclusion: Simplify Global Hiring and Employee Management with Skuad

Severance pay reflects your commitment to employee welfare even after termination of employment contract. However, laws regarding severance pay may vary across different countries, adding to the complexity of managing employee policies. 

Here’s where an HR outsourcing solution like Skuad can help. 

Skuad is a comprehensive EOR platform (employer of record) designed to streamline your global hiring, payroll, onboarding, offboarding, and benefits administration. 

With Skuad, you can expand globally in 160+ countries by outsourcing the complexities of HR compliance.

Book a demo today to learn more about its use cases.

FAQs

1) How does severance pay usually work?

Severance pay benefits are usually based on length of employment service, company policies, compliance with local labor laws, and present economic circumstances. They are mostly used to demonstrate ethical workforce management. Also, if you’re thinking - ‘how long does it take to get severance pay’, it typically takes a few weeks depending on company policies.

2) What is the most common severance package?

The most common severance package is lump sum payments upon termination of employment. In the tech industry, employees are even offered ESOPs as an alternative to severance pay. 

3) How do you calculate severance pay?

You can calculate severance pay based on the tenure of employment and applicable labor laws regarding severance pay. It is usually calculated on a fixed number of weeks per year of service. However, you can have a company-specific formula to cater to the specific needs of your niche. 

4) What are the disadvantages of severance pay?

Severance pay aids employees during the transition period; however, it can put additional financial compliance and strain on the company. Moreover, it may delay the exit period due to paperwork compliance. In most cases, severance payments are also taxed, which adds to employees' losses. 

5) What is the Rule of 70 for severance?

In the United States, the "Rule of 70" for severance is a simple way to determine if an employee is eligible for retirement-related. If the sum of the employee's years of service and age is 70 or more, you can combine retirement benefits as severance pay.