Companies are sometimes forced to terminate even loyal, hard-working employees. Although choosing to let someone go isn’t an easy decision for business leaders, job loss is far more impactful for the departing worker.
Unfortunately, whether due to economic difficulties or downsizing, a business may require personnel reductions to remain viable. It’s the logical decision — but if you’re the one receiving the news of a layoff, it can be an emotionally challenging experience.
There’s a way your former employer can cushion the blow and provide you with a measure of financial security while transitioning to a new job: a severance package. Find out what a severance package is and how it benefits you as an employee.
What’s a severance package?
A severance package compensates workers when their employment is terminated through no fault of their own. The usual reasons for this type of termination are layoffs, business restructuring, or a mutual agreement to part ways. Also known as a severance agreement, compensation may take the form of cash payments and/or an extension of benefits to help provide financial stability during the former employee's job hunt.
Severance packages are reasonably common. As of 2018, 88% of U.S. companies offered termination benefits, but the decision to provide a package was discretionary.
No state or federal law, including the Fair Labor Standards Act (FLSA) from the U.S. Department of Labor, requires a company to offer termination benefits to former employees. Companies aren’t required to pay severance unless one of these terms is met:
This doesn’t mean that if the above don’t apply, that workers don’t have recourse. The Worker Adjustment and Retraining Notification Act (WARN) requires companies with 100 employees or more to give their workers a 60-day notice in case of a mass layoff or company closure. If a company fails to do so, they're liable for back pay.
At the state level, governments have the authority to expand upon this minimum requirement. For instance, state law in New Jersey was extended protection under the WARN Act in March of 2023, requiring employers to offer 90 days’ notice and provide a severance payment of one week of pay equivalent to their salary for every year a worker was employed.
Until early 2023, a company could require employees to sign a waiver agreeing to relinquish any legal claims or prevent disclosure of the terms of the separation agreement in exchange for severance benefits — but this is no longer the case. However, non-compete clauses and confidentiality agreements aren’t included in this ruling, so your employer can still ask you to agree to these provisions.
Elements of a severance package
Because there are no legislative requirements, how much a severance package pays varies between companies and industries. A typical severance package example might include:
1. Wages
Employers must pay all salary earned by an employee until their termination date. Severance is compensation paid in addition to any employee’s final paycheck, distributed as a lump sum or regular payments following a set schedule.
Generally, the amount of severance your employer pays is based on years of service. Companies can create their own formulas taking into account seniority, job title, as well as length of employment. A typical package offers 1–2 weeks' salary for each year of employment.
If you’ve been at a company for eight years and earn $1,200 per week, your severance would be calculated as:
$2,400 (2 weeks’ pay) x 8 (years of service) = $19,200
Depending on the state, your employer may also be required to compensate employees for unused paid time off or vacation time. However, there are no federal regulations governing sick leave, so it varies across employers. They may also include previously unreimbursed business expenses.
No matter how severance is calculated, it is still subject to state and federal taxes. Don’t forget to factor in these deductions when projecting your severance payment.
2. Healthcare benefits
If your company employs 20 or more people enrolled in a health insurance benefits package, it’s obligated to provide temporary access to employees to access group coverage following termination.
The Consolidated Omnibus Budget Reconciliation Act (COBRA) allows former workers the option to continue their insurance coverage for up to 18 months. During that time, your company isn’t required to pay health benefit premiums — the individual carries the total cost, plus 2% to cover administrative fees. This can be quite expensive, but some employers will temporarily cover a portion of COBRA as a goodwill gesture and to provide peace of mind to departing workers.
But before accepting COBRA coverage, you should investigate your options for health insurance through a Marketplace plan. Job loss is a qualifying event that provides 60 days outside of the open enrollment period to sign up for coverage.
3. Retirement benefits
The type of retirement or pension plan dictates how companies include employees' retirement savings in their severance package.
Employees enrolled in a 401(k), profit-sharing, or another defined contribution plan may receive a lump sum payout. In the case of a 401(k), depending on the amount saved, employees can choose to have their money remain in their employer’s plan, roll it over into an Individual Retirement Account (IRA), or move it into their new employer’s retirement fund.
If you’re enrolled in a defined benefit or contribution fund, such as a pension, provisions in the plan’s documentation will outline payments. Typically, you’ll receive funds at the designated retirement age, unless otherwise noted.
4. Outplacement services
Another common severance package element is job placement services. As part of offboarding support, your employer could provide you with resources to help you find new employment. Services include job search training, career coaching (especially helpful if they want to make a career pivot), help with your resume, interview preparation, and more.
Severance negotiations
Normally, employees have 21 days to accept an employer’s severance package offer. During that time, they may decide to advocate for improved terms.
As with employment contracts, it’s not uncommon for workers to negotiate a severance package with their former employer. There are many reasons to do so, including:
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Unemployment benefits: Can you collect unemployment if you get a severance package? Yes, some states allow payment of unemployment benefits claims while receiving severance pay. However, the benefit amount is likely reduced based on the person’s severance payments. In that case, negotiating a lump sum payment upfront may be in the worker’s best interest so they can collect greater benefits going forward.
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Tax rates: Severance packages are subject to income tax in the year they’re paid. Employers typically withhold the usual federal income tax, state income tax, Social Security, and Medicare taxes from these payments as they would with a regular paycheck. Depending on the timing, receiving your severance in installments can reduce your yearly earnings thereby lowering your overall tax rate.
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Wrongful termination. If an employee feels they’ve been unfairly dismissed, they may try to negotiate a better severance package, hoping that the company would prefer to avoid the costs of a legal claim. This option is available to you if you feel you have faced wrongful termination.
When navigating negotiations, you may choose to consult with an employment lawyer to see if it’s possible — and reasonable — to accommodate your requests.
Benefits of severance pay
While it’s difficult to be let go, with a severance package, you know you have some security to lessen the negative impact of unexpected job loss. A generous severance agreement can also:
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Maintain relationships: Offering severance benefits demonstrates that a company cares for its workers and wishes to remain on good terms. When your former employer is ready to expand its workforce again, you might be someone they call. And if the severance package was generous, you may be willing to return to their fold.
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Improve morale: Going through a round of layoffs can be almost as stressful for those who remain as it is for departing employees. Knowing that, if your turn comes, the company will take care of you until you land a new job may reduce anxiety and improve morale.
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Preserve company reputation: Significant dismissals might affect you even if you aren’t among those receiving a pink slip. Staff layoffs can impact a company's reputation if the news picks up the story or if it’s posted about on social media. If you work in a client-facing role, interact with other businesses, or handle recruiting, a negative reputation after colleagues are let go could make your job more difficult. But if your employer takes all the proper steps to fairly compensate departing employees, it helps to safeguard the organization’s reputation and maintain positive brand perception.
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Offer financial stability: Layoffs and furloughs go beyond impacting employees. It also affects their family’s well-being, both physically and mentally. Generous severance benefits can soften the blow, helping you care for your dependents and providing stability in difficult times.
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Reward contributions: Letting go of an employee who has dedicated years to a company can seem ungrateful. A robust severance package shows you that your efforts are recognized and appreciated, even if they’re no longer needed.
A necessary safety net
Layoffs and terminations are a part of doing business, but that doesn’t make it any easier to hear you’ve been let go. However, a comprehensive severance package can take some of the sting out of a corporate shakeup and set you up for future success. A strong agreement provides you with financial stability and resources to help you in your job search so you have the space to look forward to bigger and better things.
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