Entrepreneurship isn’t easy.
Being an employer, there are so many things you must know.
While hiring, compensation, accounting, taxes are often-discussed subjects, employers might not be aware of a few aspects – like severance pay.
Layoffs might happen. You might shut down a process or position due to increasing business costs. So, by knowing about severance pay, you can help your employees ease the blow of a layoff.
Through this blog, we will tell you the nitty-gritty of severance pay. So, let’s start!
What Is Severance Pay?
Severance pay is the remuneration and/or benefits that an employer offers to an employee at the end of their employment. It can be in checks or non-monetary benefits like health insurance or placement assistance to help employees get a new position.
Severance pay is for employees who might lose their positions due to company downsizing. It is also offered to retired employees who resign or are fired.
Severance pay is generally a goodwill gesture that an employer shows towards their employee. Providing it to employees demonstrates supporting them during the buffer period between working and unemployment.
Why Offer Severance Pay?
The law does not regulate severance pay. That means no law requires employers to provide severance pay.
Then why do businesses offer severance pay?
To ensure goodwill in the industry and maintain good public connections.
Severance pay aims to help employees during the unemployment period and create a positive brand reputation.
Businesses failing to provide severance pay generally attract negative public relations. It hampers the overall image of the organization. For instance, in 2018, Sears announced that it planned to lay off its hourly employees without any severance pay. Further, the organization also announced its plan to pay millions to its executives. As a result of these announcements, Sears faced lots of criticism from the public and employees.
How Does Severance Pay Work?
If you are thinking about how severance pays work, read this section carefully to understand the workings of this goodwill gesture.
As we said, employers are not bound by law to provide severance pay. Typically, some companies have set policies regarding severance pay.
There is a typical formula for severance package: providing one or two weeks of pay for each year of service provided by the employee. It is usually a monetary benefit. The employers provide the entire pay through severance checks or a lumpsum amount. Additionally, employers might also choose to add other items to the complete severance package for the employees. However, severance packages are negotiable.
Note that severance pay counts as taxable income. If you provide the severance pay at once, you need to know the underlying tax liability.
Who Gets Severance Pay And How Do Companies Determine Severance Pay?
Another important thing for you to know is whom to provide severance pay.
Typically, severance checks or benefits are for those salaried employees who face layoffs or whose positions cease to exist. However, there can be situations where the employer hasn’t fired an employee but argued for severance pay.
For instance, suppose you eliminate a position, and the employee has not been reassigned to another one. Based on your company policies, such a situation can trigger ‘severance pay eligibility. That means the employee can be eligible for severance pay even though you retain the individual.
Negotiations might be complex when such situations involve senior employees working with you for several years or holding senior positions. Typically, such employees have more leverage to negotiate than newer ones.
Coming to how to calculate severance pay, it might vary from business to business. The severance check or benefits depend upon the industry in which you operate. Plus, another determinant is the role of the terminated employee.
On employee termination, severance pay is generally determined by;
- The size of your organization;
- How long an individual has been working in your company; and
- The employee’s position and rank within your management.
Here’s how you can calculate it for an employee (with example).
- Take a week or two of the salary of the employee.
- Multiply the considered salary by the number of years worked in your organization.
- Note that some employers offer up to four weeks’ salary for each year worked.
Example: Suppose an employee has worked in your organization for 10 years, and the individual made $2000 per week. If you decide to grant a severance of 4 weeks’ pay for each working year, the severance pay would be – $80000 ($2000 per week x 4 weeks x 10 years worked at the company).
Generally, companies prefer calculating severance pay using this method. But you might calculate it in other ways that best suit your business needs and policies.
Severance Pay Or Packages Coverage – Clear your Doubts
Now that you know what severance pay is and that it is negotiable, you must know all you can include in your severance pay packages.
Apart from severance checks, employers can include certain benefits as a part of the severance pay package. Here are a few advantages that employers provide in the severance package:
- Health insurance for a few months
- Assistance for employee placement in other companies
- Holiday pay, sick pay, or payment for unpaid holiday times.
- Disability income insurance or continuing life insurance.
Besides these, as an employer, you can include other severance pay benefits in your package in the company policies.
Do Businesses Have To Offer Severance Pay?
According to the US Department of Labor, there are no severance pay laws stating that an employer must provide employees with severance pay. In other words, no law dictates that employers must offer severance pay.
However, if an employer includes severance pay in the employment contract or handbook, the organization will be legally obliged to provide severance pay upon dismissal. That means, if the organization promises severance pay (through contracts or documents), the employer must provide it. Not only writer contracts, if the employer makes a verbal promise to provide severance pay, but they must also uphold the agreement.
It doesn’t matter if an organization offers severance pay. But according to the Fair Labor Standards Act, an employer must pay the terminated employee for their last day at work. Additionally, the employer must pay any accrued vacation period as well.
When Do Companies Offer Severance Pay?
Employers are often confused about when severance pay is required. Though there is no law regarding severance pay, you might choose to provide it under the following circumstances;
- Retirement
- Layoffs
- Elimination of job position
- Mutual agreement between employer and employee to part ways
Offering severance pay to employees is up to the discretion of the employer. If an employer wants, they might include it in their company policies. For example, if an employer conducts layoff due to changes in the organizational structure, the terminated employees will not be entitled to severance pay automatically.
However, an employee might be legally entitled to receive severance pay if the company exceeds a certain number of employees, plans a layoff, and fails to offer prior layoff notice to employees. Check out the national and state labor laws regarding severance pay.
Individual Severance Pay
Let’s talk about individual severance pay now.
If there is a sudden termination, individual employees might receive severance checks and benefits. Here’s a list of reasons why companies choose to provide severance pay to employees;
- As a parting compensation to employees to maintain goodwill
- To make sure that the employee doesn’t file any lawsuit against the company for unpaid wages, discrimination, or unjust dismissal
- It might be so that the employment contract included severance pay at the time of hiring an employee
- On a condition (known as a non-disparagement clause) that the terminated employee will not write negative stuff about the company
Note: An employee is not entitled to severance pay if terminated for poor job performance.
Severance Packages In Different Countries
We have talked about severance pay, individual severance pays, and severance pays laws. But what we know as severance pay, might be differently known in other countries. So, let’s see what severance pay by country is all about.
Canada
In Canada, severance agreements are more than a token of gratitude from employers. The amount of the severance check varies between the common law and employment law.
The goal of severance pays here is to provide sufficient notice or pay in lieu for the employee to find other suitable employment.
Coming to termination in Canada, it varies from one territory to another. Based on the Canada Labor Code and federal labor standards, on dismissal, an employer must provide a termination letter stating the just cause of termination.
If the employee has worked in the company for a minimum of 3 months, giving the individual a 2 weeks’ notice is a must. Else, the employer might pay the equivalent amount of the employee’s 2 weeks’ wages.
Further, a dismissed employee who has completed at least a year of employment with the company is entitled to severance pay of 2 days’ pay for each working year.
United States
The US Fair Labor Standards Act has no law that requires an employer to provide severance pay.
In the US, severance pay is dependent on the company policies or mutual agreements between an employee and employer.
Besides, severance pay agreements can prevent an employee from writing negatively about the company and working for a competitor.
United Kingdom
In the United Kingdom, there is no standard or formal termination process. Employers may terminate as they deem fit. But the termination must be fair and justified. Also, employers must issue a warning when appropriate, allowing some time for the employee to correct their errors.
In case of intolerable misconduct, issuing a warning is not necessary. An employer might dismiss the individual immediately.
An employer must provide a minimum mandatory notice to employees before dismissal. The period for the termination notice depends on the number of years of service:
- One week – for employees employed from one month- 2 years
- An extra one week for every working year, up to 12 years
- 12 weeks – for employees working above 12 years
An employer must show the genuine reason behind eliminating the employee’s position in a redundancy situation. Here, the employee is entitled to redundancy pay if the employee has met the following criteria:
- Worked for at least two years
- Worked under an employment contract
- Laid off, dismissed, or requested to work at reduced hours.
Note: If the employee chooses early retirement, they will not be entitled to redundancy pay.
An employee can receive a maximum of £16,320 (as of 2021) as redundancy pay.
China
The labor laws in China are favorable when it comes to employee dismissal. But they do vary in each province.
It is quite difficult for companies to terminate employees after their probation period. Before termination, they must be allowed to undergo training or transfer to some other job position within the company. After training and transfer trials, the company can begin the dismissal process, given, the employee does not fit any of the job responsibilities.
In any case, employers must provide 30 days written notice to the employees. Though in most cases, employees are entitled to severance pay, there are a few exceptions in most cases.
- An employee is on probation and shows an inability to perform responsibilities.
- Employee breaches company laws.
Coming to the severance check amount, here’s what it looks like in China.
- One month’s wages (for every working year) – for employees who have worked for over one year
- Half a month’s wages – for employees who have worked for six months or less
Note: For calculation purposes, completion of 7 months is rounded up to one year. And severance pay is capped at 12 months.
There are no specific laws applicable for the dismissal of employees due to redundancy. In cases of redundancy, the employer must negotiate and come to mutual terms with the employee considering their termination.
Australia
In Australia, it is a must for employers to provide written notice to employees before dismissal stating valid reasons for doing so.
The period of notice depends on the number of years an employee has been working in the company.
- For less than a year of employment – One week’s notice
- For 1-3 years of employment – 2 weeks’ notice
- For 3-5 years of employment – 3 weeks’ notice
- For above 5 years of employment – 4 weeks’ notice
- Additionally, if an employee has worked for a minimum of 2 years with the company and is over 45 years, they must get an additional week of notice.
The employer does not need to provide notice for dismissal due to gross misconduct.
To calculate redundancy pays, you must consider the employee’s years of employment with the company.
- Minimum 1 year but less than 2 years of employment – 4 weeks’ wages
- Minimum 2 years but less than 3 years of employment – 6 weeks’ wages
- Minimum 3 years but less than 4 years of employment – 7 weeks’ wages
- Minimum 4 years but less than 5 years of employment – 8 weeks’ wages
- Minimum 5 years but less than 6 years of employment – 10 weeks’ wages
- Minimum 6 years but less than 7 years of employment – 11 weeks’ wages
- Minimum 7 years but less than 8 years of employment – 13 weeks’ wages
- Minimum 8 years but less than 9 years of employment – 14 weeks’ wages
- Minimum 9 years but less than 10 years of employment – 16 weeks’ wages
- Minimum 10 years – 12 weeks
Note: A reduction occurs in the redundancy pay from 16 to 12 weeks with a minimum of 10 years of continuous service.
Severance Pay And Unemployment – Points to Keep in Mind
Are severance pays and unemployment benefits related? If yes, how does severance pay affect unemployment compensation?
Well, let’s discuss this in brief!
Severance pay does affect unemployment compensation. It can happen in two ways.
As an employer, if you pay the employee their severance pays in a lump sum, the dismissed employee can apply for unemployment insurance immediately as they no longer are a part of your organization’s payroll.
However, some companies choose to issue severance pay over several months. Technically, the employee remains a part of the company’s payroll even though they do not work with the company. Hence, the employees cannot apply for unemployment. In the same way, if the employee has an unused vacation period, as they use it, they remain on the company payroll as they use it.
Apart from these, severance pay affects unemployment compensation because employees sign contracts when accepting their severance pays. In exchange for severance pay packages, companies make the employees’ sign statements saying they resigned from their jobs in these contracts. Such contracts do not allow the employees to claim their unemployment insurance because unemployment insurances are applicable in layoffs only.
Note that the laws related to severance pay and unemployment compensation or benefits differ by state. So, it is significant to check with the local authorities when applying for unemployment benefits.
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