What Is a Severance Package and How Does It Work? 

Severance packages provide employees with compensation and other benefits when they’re involuntarily terminated. Employers need to balance multiple factors, from legal compliance to cost management, when designing a package.

This guide explains how severance pay works and what your employers should consider when creating a package.

What Does a Severance Package Include?

Every organization has its own approach to designing a severance package. Some employers follow a formal severance plan or policy that sets a package’s provisions in advance. Others work on a case-by-case basis. 

Most severance packages include some combination of the following:

• Severance pay: One or more cash payments an employee receives from their employer. This is separate from any compensation they’ve earned in the most recent pay period, called final wages. Some states require employers to pay accrued PTO as final wages instead of severance pay.

• Benefits: Continued access to employer-sponsored benefits following termination, such as health, dental, and vision insurance.

• Transition support: Access to outplacement services that help an employee’s new job search. These services commonly include career counseling and resume help. 

A severance agreement establishes a package’s terms. Most include a release of claims that limit the employee’s ability to pursue legal action against the employer in exchange for severance benefits. Including this provision is standard practice, but the scope and enforceability of a release depend on applicable state and local law, as well as any union agreements in place. Always consult legal counsel when drafting an official agreement.

Severance agreements may include provisions addressing an employee’s share of ownership in the company, often called equity awards. The treatment of these awards is usually governed by different policies and documents (such as an equity incentive plan) instead of a severance agreement.

When Might Employers Offer a Severance Package?

Employers may offer a severance package to an employee who’s terminated for a non-performance-related reason, such as restructuring. Treating departing employees well can make the transition easier while buoying the company’s reputation.

Employers may, in some cases, offer severance for voluntary resignations. But they don’t typically offer packages to employees who are fired due to poor performance or misconduct. 

What Is Severance Pay?

Severance pay is the monetary compensation (usually cash payments) that an employer provides as part of a severance package.

Employers typically provide severance payment as either a lump sum or a series of installments made over time as part of the regular payroll process. Severance pay is a taxable wage that may be subject to supplemental wage withholding rules. It’s important for organizations to correctly process these payments, so using an HR platform with dedicated payroll tax support, such as Justworks, can help.

When Do You Get Severance Pay?

Federal law generally doesn’t require employers to provide severance pay when an employee is terminated. According to the U.S. Department of Labor(opens in a new tab), severance pay is a “matter of agreement” between an employer and an employee. 

However, some states impose severance requirements in specific circumstances. For example, the New Jersey WARN Act(opens in a new tab) requires employers with over 100 employees to provide a minimum of one week of severance pay for each full year of an employee’s service. This only applies to certain terminations, such as mass layoffs or plant closures.

How Is Severance Pay Calculated?

There’s no single, universal formula for calculating severance pay. Employers may consider several factors, including: 

• Length of service: Severance pay is commonly based on how long an employee has worked for the company. For example, an employer may provide between one and four weeks’ worth of pay for every year of service. 

• Position: Senior employees may have more leverage to negotiate favorable terms, sometimes through employment contract negotiations. For example, they may ask for severance pay based on months of service instead of years. 

• Company financials: An organization’s financial position may impact the size and structure of a severance package, including whether payments are made as a lump sum or in installments. 

Example Severance Pay Calculation

Suppose a marketing manager earning $85,000 is laid off after four years and five months. The company has a set policy of offering two weeks’ pay for each full year of service. 

Weekly base pay: $85,000 ➗ 52 = $1,634.62

Eligible service: 4 full years

Severance pay: $1,634.62 ✕ 2 weeks ✕ 4 years = $13,076.96

The manager would receive approximately $13,076.96 in gross severance pay before applicable taxes and withholding.

What Should Employers Consider When Creating a Severance Package?

There are several factors business leadership should consider when creating a severance package. 

Legal Compliance

Employers must comply with all applicable local, state, and federal laws. This includes following laws that provide group-specific protections, such as the Older Workers Benefit Protection Act(opens in a new tab) (OWBPA) and the Americans with Disabilities Act(opens in a new tab) (ADA). 

Employers should consult legal counsel to ensure compliance when designing and offering severance packages. Teams should identify which agreement terms are fixed by law or contract. To avoid unanticipated legal exposure, understand each provision’s legal implications in full. For example, a release of claims clause limits an employee’s ability to sue the company, but they can’t bar complaints related to the Equal Employment Opportunity Commission (EEOC).

Employers should apply their severance policies fairly and consistently to minimize legal risks and protect the company’s reputation. But you don’t need to make every package identical: Leaders can and should account for legitimate differences in tenure, reasons for separation, and employment agreements when designing each package.

Communications Strategy

Discuss the severance agreement’s terms with the employee away from their coworkers. This conversation typically involves the employee, their direct manager, an HR representative, and occasionally legal counsel. It usually takes place alongside the initial notice of termination.

Make sure to communicate the severance terms clearly—ambiguity increases the likelihood of disputes. 

The terminated employee should have a clear understanding of their package, including:

• Compensation

• Benefits

• Payment timing

• Important dates

• Agreement terms

• Next steps

Support Departing Employees with Justworks

Managing an employee separation involves more than calculating severance pay. HR teams need to coordinate payroll, benefits, and offboarding—all while handling the employee’s departure with care and thoughtfulness. Justworks PEO and HR Consulting can help teams reduce the administrative burden and keep the separation process smooth. 

If you want a streamlined way to coordinate multiple HR tasks in one centralized platform with 24/7 support, get started with Justworks today.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.

FAQ

Can an Employee Negotiate a Severance Package?

Yes. Employees can generally negotiate the terms of a severance package. However, certain provisions are fixed or constrained by applicable laws and contractual agreements.

Can Employers Change an Existing Severance Policy?

Yes. Employers can typically change or cancel an existing severance policy, subject to the terms and structure of the plan, including whether it’s subject to ERISA or other requirements. Employers should seek legal counsel prior to implementing policy changes. 

Can Severance Be Offered When an Employee Resigns?

Yes. Employers may offer severance to employees who voluntarily resign. However, this is uncommon. Employers typically offer severance packages to employees upon involuntary termination unrelated to performance.

How Does Severance Affect Unemployment Benefits?

It varies by state. In California, for example, severance pay does not affect eligibility for unemployment benefits (certain conditions apply). Other states may reduce or delay benefits. 

What Is a Standard Severance Package’s Purpose? 

Severance packages provide employees with support, including financial assistance, following termination of employment. They also help reduce the employer’s legal risk, as many severance agreements include a release of claims or a non-compete clause.

How Much Is Severance Pay?

Multiple factors influence severance pay, including the employee’s length of service and the employer’s internal severance policy. Employees may also negotiate their pay. 

What States Require Severance Pay?

No state uniformly mandates severance pay. A small number of states, such as New Jersey and Maine, impose limited requirements. In most cases, severance pay is a matter of agreement between the employer and employee.