Severance Pay

Severance pay is compensation an employer gives to an employee when their employment ends, such as in the event of a layoff or downsizing. While it is not required by law, many companies offer severance pay to provide their employees with a financial cushion as they transition to new jobs or retirement. It can also help mitigate legal risks in the event of an involuntary termination without cause.

In addition to the actual payout itself, severance packages may include additional benefits such as continued health insurance, outplacement services or company-provided equipment like a cell phone or laptop. The payout of severance pay is usually taxed as income, although the amount that an employee receives depends on their individual financial situation.

The most common reason that companies provide severance pay is to give employees a financial cushion as they transition from one job to the next, especially during times of workforce reductions or layoffs. This money can be used to cover the cost of a job search, continue health coverage or retrain for another career. Providing severance pay is a way to demonstrate that the company cares about its employees and can strengthen the employer-employee relationship.

If a company offers severance pay, it may require that the employee sign a non-compete or confidentiality agreement as part of their exit package. This helps protect the company from potential lawsuits brought by former employees who have a competitive advantage over them. It is not uncommon for severance packages to include a signing bonus, which can be worth as much as six weeks of salary.

What Is Severance Pay?

Companies that don’t provide severance pay risk losing goodwill with the former employees, which can lead to negative reviews and social media outrage. In addition, the company may have to pay for wrongful termination suits filed by disgruntled employees.

While it is not required by law, severance pay can be a good incentive for employers to attract talent and protect them from the impact of involuntary terminations. The exact calculation of how to get severance pay differs from company to company, but it is generally based on the number of years the employee has worked at the organization. Most companies choose to give out two weeks of pay for every year of service, with a maximum of four weeks.

Some companies take a “take it or leave it” approach to severance packages and will not negotiate, but others are more open to discussion. An employer that is concerned about an employee filing a wrongful termination lawsuit may be willing to increase the severance package in exchange for a signed non-compete or confidentiality agreement, for example. If you are considering accepting a severance package, it is a good idea to consult with an advisor for help navigating the complexities of this arrangement. The financial professionals at Northwestern Mutual can help you determine the right strategy for maximizing the benefit of your severance pay.

In cases where severance pay is offered, the amount can vary widely. It may be calculated based on a set formula tied to the employee’s salary and years of service, or it could be a predetermined lump sum. Some companies also offer additional benefits such as continued health insurance coverage or assistance with job placement as part of the severance package.