Severance Pay:
Definition, Comparison & Benefits

Severance pay is compensation that an employer provides to an employee upon termination of employment, beyond what is owed in remaining paychecks or unused time off. It is usually based on length of employment and is often granted to employees who are laid off or terminated through no fault of their own, though it may occasionally be offered to employees who resign or are terminated for performance-related reasons.

There is no federal requirement in the Fair Labor Standards Act (FLSA) for employers to provide severance pay. According to the U.S. Department of Labor, severance pay is a matter of agreement between an employer and an employee or the employee's representative. When offered, it typically serves as a financial cushion to help terminated employees transition to new employment.

Related terms: severance package, termination benefits, separation pay, exit package

A severance package commonly includes 5 key components:

• Severance payment, either as a lump sum or periodic payments based on years of service
• Payout of unused paid time off (PTO), including vacation time and sick time
• Continued health insurance coverage at the same rate for a certain period of time
• Continued dental, vision, and life insurance at the same rate for a certain period of time
• Outplacement services, such as career counseling, training, and job placement assistance

In some cases, severance packages also include stock options, retirement benefits, continued company perks such as employee discounts, and the ability to keep company equipment like laptops. The specific components and their value vary substantially from company to company and depend on factors such as the employee's position, length of service, and the circumstances of termination.

Severance pay calculation depends on the employer's policies and typically follows a formula based on length of employment. A common severance pay formula pays out 1 to 2 weeks' worth of wages for each year of employment, though some companies use a flat amount instead.

For federal employees covered by 5 U.S.C. 5595, the basic severance pay allowance is calculated as one week of pay at the rate of basic pay for each full year of creditable service through 10 years, two weeks of pay for each full year beyond 10 years, and 25 percent of the otherwise applicable amount for each full 3 months of creditable service beyond the final full year. Federal employees may also receive an age adjustment allowance consisting of 2.5 percent of the basic severance pay allowance for each full 3 months of age over 40 years.

The weekly rate of basic pay for employees with variable work schedules is determined based on the weekly average for the last position held during the 26 biweekly pay periods immediately preceding separation.

Severance pay is taxable income according to the IRS. It is taxed in the year it was received, and employers typically automatically withhold taxes from severance payments. Severance pay is included as part of the total income listed on the W-2 form the employer sends for the year they paid the severance.

How much tax is withheld depends on how the employer pays the severance. If the employer pays severance as part of normal wages, the same withholdings apply that would normally come out of regular paychecks. If the employer pays severance as supplemental wages, the employer may apply a flat withholding rate of 22 percent or use another IRS-approved option. If unused PTO is cashed out as part of the severance package, that income is also taxable.

In February 2010, a ruling in the Western District of Michigan held that severance pay is not subject to FICA taxes, but this was overturned by the Supreme Court in March 2014.

Employers offer severance pay for 3 primary reasons:

• Compassion and goodwill toward employees, particularly those with many years of service or those terminated due to events beyond their control such as layoffs or restructuring
• Mitigation of legal risks, as severance agreements typically stipulate that the employee cannot bring legal action against the employer if they accept severance pay, potentially avoiding costly wrongful termination lawsuits
• Brand and reputation management, as offering severance helps maintain a positive image with remaining employees, investors, and future job candidates

Offering severance pay demonstrates appreciation for employee contributions and provides financial support during the transition to new employment. Attorney fees and settlements can accumulate rapidly, so offering severance may keep costs down overall when companies downsize or restructure. Some businesses offer severance pay simply because they want to do right by their former workers, regardless of the costs to the business.

Severance pay is negotiable at 2 key moments: during the hiring process when reviewing the job offer, and after receiving a severance offer following termination or layoff.

During the hiring process, job offers may or may not include severance pay terms. If the offer does not mention severance, candidates can request to add it. If it includes severance but the terms are unsatisfactory, candidates can attempt to negotiate better terms. However, discussing job loss before starting a new position might raise concerns with some hiring managers unless the industry is known for frequent layoffs.

After termination, employees who receive a severance package do not have to accept it immediately and can use the decision period, typically a few days to a few weeks, to negotiate. Offering something in exchange can strengthen the negotiation, such as signing a non-compete or non-disclosure agreement, volunteering to train employees on tasks they will be taking over, or presenting data on what competitors offer in severance. However, negotiating carries risk, as employers may decide to rescind the severance offer altogether.

Whether an individual can collect severance pay and unemployment benefits simultaneously depends on state law. Some states prohibit it entirely. Some states allow it but reduce unemployment benefits based on the amount of severance received. Other states allow both because they do not treat severance pay as income for unemployment benefit purposes.

In states where receiving severance affects unemployment eligibility, individuals may not be eligible for unemployment benefits immediately. In such cases, it may be worth negotiating to receive severance pay after unemployment benefits expire, if financially feasible. Rules for unemployment benefits vary significantly by state, so individuals should check with their state's unemployment office for specific guidance.

No federal or state law in the United States requires companies to offer severance pay in most circumstances. As the U.S. Department of Labor states, "Severance pay is a matter of agreement between an employer and an employee (or the employee's representative)."

Exceptions exist when an employment contract or collective bargaining agreement specifically calls for severance pay. In Puerto Rico, employers are required to pay severance pay after an employee is terminated without "just cause," and employees cannot waive this payment. For most at-will employees in the United States, who can be terminated for any legally permissible reason at any time, severance packages are not mandatory.

Under the Worker Adjustment and Retraining Notification (WARN) Act, employers may be required to provide severance in lieu of adequate notice during mass layoffs or facility closures. The Employee Benefits Security Administration (EBSA) may assist an employee who did not receive severance benefits under their employer-sponsored plan as outlined in their employment contract.

Eligibility for severance pay depends on employer policies and, in some cases, legal requirements. For federal employees covered by 5 U.S.C. 5595, eligibility requires employment by a covered agency, serving under a qualifying appointment, having a regularly scheduled tour of duty, completing at least 12 months of continuous service, and being removed from Federal service by involuntary separation for reasons other than inefficiency (unacceptable performance or conduct).

An employee is not eligible for federal severance pay if they are serving under a nonqualifying appointment, decline a reasonable offer of assignment to another position, are receiving injury compensation under 5 U.S.C. chapter 81, are eligible upon separation for an immediate annuity from a Federal civilian retirement system or uniformed services, or hold a position with a rate of basic pay fixed at an Executive Schedule (EX) rate or exceeding the official rate of pay for EX level I.

Qualifying appointments for federal severance pay eligibility include career or career-conditional appointments in the competitive service or equivalent in the excepted service, career appointments in the Senior Executive Service, excepted appointments without time limitation (except Schedule C), overseas limited appointments without time limitation, status quo appointments, and certain time-limited Foreign Service or full-time appointments made within 3 calendar days after the end of a qualifying appointment.

The maximum amount of severance pay varies based on employer policies and applicable laws. For federal employees in the United States, an employee may not receive a total of more than 52 weeks of severance pay during their lifetime under 5 U.S.C. 5595.

In the United Kingdom, the maximum amount of statutory redundancy pay is £17,130. In the Netherlands, transition allowance is normally equal to one third of one month's taxable compensation per year of employment, and this sum cannot exceed the greater of €94,000 or one year's gross salary. In Mainland China, if an employee's monthly salary is higher than 3 times the local average monthly salary where the employer is located, the severance payment rate is capped at 3 times the local average monthly salary for no more than 12 years.

For private sector employees in the United States, there is no legal maximum, and the amount depends entirely on employer policies and negotiated agreements.

If an individual receiving severance pay accepts a position with the Federal Government or the government of the District of Columbia, severance pay terminates unless the new employment is under a nonqualifying time-limited appointment. The employing agency must record on the appointment document the number of weeks of severance pay the individual has received.

If the employee again becomes entitled to severance pay, the agency from which the employee is involuntarily separated must recompute the severance pay allowance based on all creditable service and the individual's current age. The agency deducts the number of weeks for which severance pay was previously received from the number of weeks it would take to exhaust the recomputed allowance.

If an individual entitled to severance pay is employed by the Federal Government or the government of the District of Columbia under a nonqualifying time-limited appointment, severance pay is suspended during the life of the appointment but resumes without being recomputed when the employee separates from the nonqualifying time-limited appointment. The resumed severance payments are the responsibility of the agency that originally separated the individual involuntarily.

Severance pay is often compared to 3 related compensation concepts:

Severance Pay vs. Unemployment Benefits: Severance pay is compensation provided directly by the employer upon termination, based on factors such as length of service and company policy. Unemployment benefits are government-administered payments available to eligible workers who lose their jobs through no fault of their own. Whether an individual can receive both simultaneously depends on state law, with some states reducing unemployment benefits based on severance received.

Severance Pay vs. Golden Parachute: A golden parachute is a specialized form of severance designed for top executives and typically includes substantial cash payments, stock options, and continued benefits triggered by specific events such as mergers, acquisitions, or hostile takeovers. Standard severance pay is broader in application, available to employees at various organizational levels, and is generally based on tenure and position rather than corporate control events.

Severance Pay vs. Redundancy Pay: Redundancy pay is a legally mandated payment in countries like the United Kingdom when an employer eliminates a position due to business needs. In the UK, statutory redundancy pay is calculated based on age, weekly pay, and years of service, with a maximum of £17,130. In contrast, U.S. severance pay is typically voluntary, not required by federal law, and amounts vary based on employer policies and individual negotiations.