Severance Pay

Key takeaways

• Severance pay is compensation employers may offer to employees whose positions are eliminated or who are laid off.
• It can include cash, continued benefits, and services (e.g., health insurance, outplacement).
• Employers are not required by federal law to provide severance unless a contract, handbook, or promise says so.
• Severance is taxable as ordinary income and may affect unemployment benefits depending on how it’s paid and state rules.
• Review any severance agreement carefully and consider legal advice before signing.

What is severance pay?

Severance pay is a form of financial support employers provide to ease the transition after involuntary job loss. Packages vary widely and may be offered as a lump sum, periodic payments, continuation of benefits, or a combination. Employers commonly use severance to soften the financial impact, maintain morale, and reduce the risk of legal claims.

Typical components of a severance package

Severance packages often include some or all of the following:
* Cash payment (lump sum or installments) — frequently tied to length of service.
Pay for accrued but unused vacation or paid time off.
Continued medical, dental, or life insurance coverage for a limited period.
Outplacement services or job-search assistance.
Acceleration or treatment of retirement benefits and stock options (varies by plan).

How severance amounts are determined

Employers typically set severance based on company policy, employment contracts, or precedent. Common formulas include a fixed number of weeks or months’ pay per year of service. Policies are usually documented in employee handbooks or individual agreements.

Example formula: 1 month of pay for every year worked.

Effect on unemployment benefits

Severance can affect eligibility for unemployment benefits, and rules vary by state:
* Lump-sum severance often allows immediate filing for unemployment insurance.
Severance paid as periodic wages or when the employee remains “on payroll” may delay or reduce unemployment benefits.
Some severance agreements require employees to sign releases or state they resigned, which can bar unemployment claims.

Always check your state’s unemployment office for specific rules and timing.

Legal obligations and employer promises

• No federal law mandates severance pay. Employers must follow any severance provisions written in employment contracts or promised in handbooks.
• Verbal promises can be enforceable in some situations.
• The Fair Labor Standards Act (FLSA) requires payment through the last day of work and generally requires payment of accrued vacation if company policy or state law mandates it.

Tax treatment

Severance pay is treated as ordinary income and is subject to federal and state income tax withholding and payroll taxes. How it’s taxed can depend on whether it’s paid as a lump sum or as wages over time; employers typically withhold taxes at standard supplemental wage rates for lump-sum payments.

Signing agreements and negotiation tips

• Read severance agreements thoroughly. They may include waivers of legal claims, nondisparagement clauses, confidentiality terms, and restrictions on future employment.
• Consider negotiating for better terms, such as more weeks of pay, extended benefits, or outplacement support.
• If the agreement includes a release of claims or complex legal language, consult an employment attorney before signing.
• Timing matters: do not assume accepting severance automatically disqualifies you from unemployment—verify with your state agency.

Example

A company offering one month’s salary for each year of service: an employee with five years’ tenure would receive five months’ pay as severance.

Final thoughts

Severance pay can provide a valuable financial cushion after job loss, but its form and consequences vary. Verify company policies and state unemployment rules, understand tax implications, and review any legal releases before agreeing to a package. When possible, negotiate terms that give you time and resources to find your next position.