Severance pay is an allowance that is paid to an employee after his service is terminated so that he does not take any legal action against the company for the dismissal. It is a contract between the employer and the outgoing employee where the former offers money as well as some other benefit to the latter.
Meaning of severance pay
Severance pay is a type of compensation money offered to an employee who is leaving the company not because of retirement but because of circumstances like a layoff, elimination of the current position, wrongful dismissal or mutual agreement.
Severance pay is often considered a courtesy by the employer for his employee so that he can find a new job without worrying about necessary expenses for some time. In some cases, severance pay is a form of protection for the employer against any potential lawsuits.
A court case for whatever reason means monetary loss regardless of the validity of claims, and to save a company time, employers opt to offer severance pay. It acts in their best interest and is a type of insurance against any such probability.
Eligibility for severance pay
An employer doesn’t need to provide severance pay to his employees, but if it is offered upfront and is one of the criteria for employment, then the company usually mentions it at the onset along with the conditions attached to it. Severance pay is offered by the employers to attain a competitive advantage over other companies and show an image of a compassionate and well-wisher employer.
An important fact about severance pay is that the employer doesn’t need to offer severance pay. If your company is undergoing layoffs, then it does not mean that you have become eligible for severance pay or additional benefit beyond your salary.
Only in case of massive layoffs for instance, if the company has more than one hundred employees and is laying off a good number of them, the law asks the employer to give a prior notice of sixty days, and in case the notice is not given only in those circumstances is an employee eligible for severance pay.
An employee who is fired without any due notice is also eligible for severance pay, but it is discretionary. It is up to the organization to offer it in exchange for agreeing to not suing for wrongful termination, unpaid wages, discrimination, etc.
Things to include in a severance pay
Several things should be considered before adding them to the severance pay.
- One of the essential components in severance pay is the money factor. Employers generally add one to two weeks’ worth payment for each year the employee has served
- In some cases, the employer continues to pay for disability, life and health insurance for a specific time even after the employment is terminated
- One of the key services that can be included in the severance pay is the outplacement service. The firm offers job leads, practice interviews, resume-writing seminars, and career counseling so that the terminated employee can find a new job
- Severance pay should include a letter of recommendation to help the employee find a suitable job
- The terms of severance pay can be negotiated to add additional benefits, for instance, letting the employee keep his vehicle or equipment or letting him continue with some special services like a gym membership
How is severance pay calculated and distributed?
The best way to calculate severance pay is by taking into consideration the number of years an employee has worked for that company. The most common practice in determining the severance package is by offering one to two weeks of severance pay for each year he has worked and proper calculations on that basis. Sick leave and vacation time also figures in making the severance pay calculations.
An important fact about severance pay is that it is negotiable and the first offer is not the final number. An employee has the right to consider various factors like his rank and position, number of years he has worked, size of the company and if the contract includes terms for severance pay before accepting any offer.
Although severance pay is monetary, an employee can ask for additional benefits along with it, for instance, continue with health insurance for a few months or until he finds a new job, keeping his vehicle or laptop as part of benefits along with severance pay.
Remember everything is negotiable and it is up to you to say a final yes or no. Understand the terms and conditions properly before signing an agreement accepting the severance pay. One important point to remember is that severance pay is taxable hence keep in mind the end figure that will reach you before agreeing to the amount.
An employer can pay the full amount of the severance pay at one go, or he can distribute it over time and make it in several installments. It is seen that in some cases, the employees ask for unemployment compensation if they are unable to find suitable jobs for themselves.
If the severance pay was a one-time payment, then the employee becomes eligible for the unemployment compensation, but if the employer has distributed it over a period, then they cannot ask the settlement until and unless the severance payment has been completed. Hence it is beneficial for the employer to distribute the severance pay over a while.
Release of claims
The outgoing employees sign a document that offers the employer and the firm a release from any further claims as part of the settlement related to the severance package. It categorically states that the organization and the employer are not in any way liable for the employee’s unemployment and frees them from potential lawsuits.
Advantages of severance pay
The various advantages of severance pay are as follows-
- Severance pay is a way to wipe the slate clean. If an employee is released from employment under controversial circumstances, then the severance pay acts as a precaution against the probable lawsuit. It is a legal waiver that guards against claims of discrimination or harassment. The legal costs of fighting a court battle are more than the severance package, and it is in the interest of the company to provide it as a safeguard against unpredictable legal costs in the future.
- Both parties have a vested interest in maintaining their reputation in the outer world. This is why one offers, and the other accepts the severance pay to keep their standing intact. The terms of the agreement, in most cases, are confidential and thus prevent both the employer and the employee from badmouthing each other.
- Severance pay is, in most cases a reward for the employee who has worked very long in the company. It is also seen as a softener against the financial blow that occurs because of unemployment.
- The severance pay provides the employer peace of mind because the sword of the threatened lawsuit is no longer hanging over his head
- The severance pay acts as a reminder to the employee not to compete with or disparage or badmouth the company or the employer
- Severance pay helps the employee to meet his necessary expenses until he finds another job
- Despite the unfortunate circumstances of termination, the severance pay maintains a viable link between the employer and the employee. This helps to maintain company loyalty despite the misgivings
Disadvantages of severance pay
The disadvantages of severance pay are as follows-
- Severance pay is seen as prolonging of already existing unpleasant circumstances.
- Employees view severance pay as an invite to negotiate the terms of their release
- The severance pay generally has a confidentiality clause, but if an employee refuses to sign, he can go public with any valuable information he has.
- Sometimes, the severance pay legitimizes the employee’s claim of discrimination or harassment and exposes the employer to reputational damage.
- If an organization starts offering severance pay to several employees, it will become a pattern, and this will be hard to break because every Tom, Dick, and Harry will now consider themselves as eligible for the severance pay.
- Severance pay increases the expenses of the company and can prove costly especially if it does not have the necessary resources to meet those expenses
- It can nudge the employee to view the severance pay as cover-up money and if he refuses to sign then can increase chances of a potential lawsuit
How to negotiate severance pay
If an organization already has specific rules and regulations to deal with severance packages, you cannot do much at the negotiation table, but in case, it does not have any written policy an employee has the option to negotiate and set the terms for his severance pay. It is important to consider the following things for better negotiations.
- Gather information regarding the length of your service, rewards for services offered if any, current earnings, position and rank in the company, etc. Keep the information handy so that you can appear confident with the details and can have your say with proof at the table
- A person who seems calm and collected always will have the upper hand at the meetings, whereas anger leads to agitation and then to mistakes and blunder. Make sure that you show your calm and confident side at the negotiation table.
- Once the organization offers the severance package, find the scope for increasing the pay. You can ask to include unused paid-time-off to be included in it.
- Once the package has been presented, look for a non-compete agreement. Use it as a leverage to increase your severance pay
- If the monetary compensation is not at par with your expectations, then you can ask for an extension of benefits.
- If the employee is unable to understand in full the language of the document related to severance pay he can hire a lawyer and take his help to make sure that all the nitty-gritty details are up to the mark,
- In some cases, the employer grants some points to the employee and rejects the others, whereas in other cases, the employer rejects all claims as he is under no obligation to offer severance pay. It is up to the employee to accept or reject the severance package hence think twice before either signing or denying it. You mustn’t let the pressure get to you because as per the laws an employee has twenty-one days to accept the agreement. Even after you have signed it, you have seven more days to change your mind. Until and unless you accept the severance pay, you are not legally bound to follow company instructions.
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