What Exactly Is Severance Pay?
Severance Pay
With layoffs and downsizing in the news, many people are wondering what exactly is severance pay. Severance pay is the money that an employer pays to an employee whose employment is terminated or the company is being sold. It is often offered as part of a package that includes continued health insurance coverage, career consultation services (also known as outplacement), unused vacation and sick time and stock options.
Companies are not required to pay severance packages, but they do it as a gesture of goodwill and to help employees find new jobs. The amount can range from a week’s worth of salary up to four weeks’ pay for each year an employee has worked. The higher the job level, the more likely it is that a severance package will be offered.
The benefits can also help companies maintain their brand in the eyes of customers and potential job applicants. If laid-off employees are treated with dignity and respect, they may post positive reviews of their experience on Glassdoor, Facebook or other social media sites. If they are bitter and angry about the treatment, they may spread that opinion to others, damaging the company’s reputation.
A severance package can include a lump sum or payments made in installments. It might also include the option to keep a company vehicle or computer, employee discounts and other perks. The amount of severance pay and what’s included in it will depend on the size of the company and its industry.
What Exactly Is Severance Pay?
Typically, employers withhold federal and state income tax, Social Security and Medicare taxes from severance pay retiring allowance just as they do from a regular paycheck. It’s taxable in the year that the payment is received and will be reported on the individual’s W-2 form. If the severance package is large enough, it can push the former employee into a higher tax bracket. In those situations, it’s in the former employee’s best interest to negotiate to receive the payment in installments rather than a single lump sum.
In some cases, severance pay can be used to cover the cost of unemployment insurance. This will reduce the severance pay’s tax impact and may be beneficial if an employee has a low tax rate.
Some severance packages include a waiver that says the former employer will not contest any unemployment claims filed by the former employee. Waiver clauses are generally included when an employer has reason to believe the worker’s firing was a result of illegal discrimination or other misconduct.
Before signing a severance package, it’s a good idea to have an attorney review the terms. In addition to the typical severance pay agreement, there may be non-compete or non-disclosure provisions that could prevent an employee from finding work in their field of expertise, or even from applying for another job with the company that provided the severance package. It’s also important to know if the severance pay will count toward your annual earnings limit for federal retirement benefits.
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