Close this search box.
Blog » Money Tips » Severance Pay: All You Need to Know about Severance Package

Severance Pay: All You Need to Know about Severance Package

Posted on August 7th, 2022
Cash Flow

How many of you acknowledge that it is legal for you to negotiate compensation and benefits after you leave an employer? Some job seekers may understand how to negotiate compensation and benefits when they are employed, but they may be unaware that they may do so after they leave an employer. Most firms provide a severance agreement outlining the financial terms of the employee’s departure from the organization.

Negotiating an appropriate agreement entails thinking about how to conduct yourself during conversations with the employer, how much money and perks you need to survive, and whether or not to hire legal counsel.

Negotiating this agreement can help to ease your transfer to a new job, decrease stress, and potentially give you a good financial cushion. However, money isn’t the only thing to talk about in these meetings; you should also consider ongoing insurance coverage, support in finding another job, and other perks. Companies don’t want you to bad-mouth them or sue them, so you have leverage in this negotiation. And they might not want you to work with or share secrets with their competitors.

People frequently wonder, “What’s the difference between severance pay and redundancy?” In a nutshell, both are forms of financial compensation for departing employees. It is critical that you grasp the distinction between the two as an employer. This will contribute to seamless operations, satisfied personnel, and legal compliance.

In this piece, we will define severance pay, determine who is eligible, and explain how it works. We will also go over some of the rules governing severance pay packages in the UK, as well as what you should consider when calculating an employee’s severance pay.

What Is a Severance Package?

A severance package is a monetary payout made to an outgoing employee or group of employees who are terminated for business reasons, such as during a round of layoffs. Employees who are displaced by a merger or acquisition may also be offered severance compensation. Severance plans are typically utilized to provide financial assistance to individuals who lose their jobs through no fault of their own.

The amount an employee earns is usually determined by the length of their work and the policies outlined in the employee handbook of the organization. In general, a severance payment typically comprises cash in lieu of notice, accrued holidays, pension payments, and additional incentives or discretionary sums as applicable.

Although severance compensation is not a legal necessity in some parts of the world, companies that provide it have a competitive advantage. They will attract and keep more talent than companies who do not offer severance payouts because of their readiness to provide safety to their employees. Severance agreements also insulate you from future claims related to dismissal.

When a departing employee signs a severance agreement, they often agree to dismiss any potential discrimination or wrongful termination claims. Then they are paid according to the terms of the severance agreement.

Severance Pay vs. Redundancy Pay

Redundancy payments and severance payments are frequently used interchangeably, but there are certain exceptions. Legal Redundancy Pay is the minimum amount that you must pay an employee if you fire them. The Employment Rights Act of 1996 states that an employee is entitled to redundancy pay if he or she is fired.

  • Their role within the company no longer exists (due to restructuring or downsizing, for example);
  • Their position at work is no longer required (for example, due to outsourcing or relocation of operations); or
  • The corporation no longer requires the duties performed by an employee (due to changes in business needs).

Statutory redundancy payments are determined by an employee’s contract, length of service, and reasons for dismissal. A severance payment might be part of a broader package that includes redundancy compensation as well as any other employee payouts like benefits and incentives.

Redundancy pay is governed by law, although you must negotiate severance packages as part of your employment agreement. When you make an employee redundant as a result of business changes (restructuring, relocating, or downsizing), you must evaluate a variety of factors in order to determine how the redundancy payout is computed.

To begin with, you can only fire an employee if you can demonstrate that their services are no longer required by the organization. If you fire an employee for misconduct or poor performance, they are not entitled to even the bare minimum of redundancy pay. This is why, employer need to be mindful in applying redundancy pay and the reasoning of why the employee is fired.

What Should be Included in a Severance Package?

It is pretty simple to determine how much money should be included in a severance package. Firms normally grant one to two weeks of salary for each year an employee has worked for the company. For example, a five-year employee earning $500 per week may receive between $2,500 and $5,000 in severance pay.

However, a company can determine the lowest amount of severance it will grant and the highest amount it will pay regardless of the number of years of employment. This ensures that when a decades-long employee departs, businesses won’t be on the hook for outrageous sums. Furthermore, severance packages must contain cash or benefits to which the employee was not previously entitled.

Inclusion of an employee’s final paycheck in a severance payout, for example, would not qualify because the individual is already entitled to compensation for the hours worked prior to leaving the organization. In some cases, businesses might also choose to include a continuation of benefits, such as medical, auto or life insurance, as part of a severance agreement.

How Should You Communicate Severance Pay to Your Employees?

When terminating an employee, all communications leading up to and surrounding the termination must be documented. The same can be said of severance pay. It is important to communicate severance benefits to employees simply, succinctly, and in writing. Employers must be able to document the full termination procedure to avoid any liability.

Furthermore, it is critical to be compassionate while dealing with employees, especially during a reduction in force. Offering an open platform to explain the situation, as well as time for one-on-one inquiries, is not only ethical, but it may also assist in boosting the morale of the staff you’re keeping.

10 Steps to Plan for Severance Packages for Small Businesses

While no company relishes laying off staff, it is especially difficult for small enterprises with a few employees who work closely together. However, there are situations when firing an employee is unavoidable. A fair severance package is essential for smoothing the transition for your former employee and demonstrating goodwill.

1. Utilize employment contract

Having your employee sign a tailored employment contract that highlights what they should pay if they terminate the contract at the beginning of their contract is a good idea. Applying this method might help you some time or other unexpected things to happen.

In addition, you have to make sure your contract is routinely reviewed by a lawyer due to law changes. If you are unaware of some legal changes, your own contract may backfire.  However, you need to carefully write the contract in order to protect the company’s interests.

2. Cause of layoff

If the employee is laid off because of their own mistakes (for instance, willful misconduct, disobedience, or neglect of duty), then your company does not need to pay the employee anything on termination. Another thing worth mentioning before terminating the employee is that you need solid proof and records of the employee’s performance along with the warnings that they received. That way, every interaction and behavior of the employee could be held accountable.

3. Make sure that it meets your state’s standard

If you’re not firing for “reason,” ensure your severance payment meets the minimal employment rules in your province, territory, or federal jurisdiction (whichever applies).

Each jurisdiction has its own standards for the amount of advance notice required for termination and other conditions. So, make sure you get into the details of every paper your state provides.

4. Consider providing reasonable notice

Employees who do not have an employment contract may be entitled to “reasonable notice.” Individual variables, such as the employee’s years of service, job held, and age at the time of termination, determine reasonable notice, which is more lenient than provincial minimum rules. Older workers and those with more years of service are typically entitled to a lengthier period of reasonable notice.

5. Sweeten the deal

You can put extras in the severance package offer to “entice” the employee and keep them from suing. Because, as we all understood, if they sue you, you will be getting another plate to finish.

For example, you could provide outplacement services to assist them in finding another job. You might also give the employee time off during the notice period to attend job interviews. A letter of recommendation is frequently appreciated as well.

6. Getting a release

You may find that in some situations, you are able to request that the employee sign a release of any claims connected to their employment with you.

However, if that is the case, any part of the details should be discussed with a lawyer to avoid misunderstandings and anything unwanted. Most importantly, getting a release might provide you with some peace of mind about pending legal matters.

7. Determine the severance agreement’s term

After carefully reviewing the employee’s paperwork, you must decide which benefits will be terminated immediately and which ones will be extended for a certain amount of time. You must calculate the monetary value of earned sick leave and other things. After that, you should be ready to repay the former employee with his or her final paycheck.

If an employee uses a company-owned device, you must decide whether the phone should be returned or kept by the employee. There will be many big and small considerations to make in determining which benefits a former employee should be entitled to maintain.

8. Wait for terms to be accepted before evaluating counteroffers

A terminated employee should try to negotiate the conditions of his or her severance payout, just as you would expect a job candidate to do before accepting a position. Again, when analyzing counteroffers, be compassionate and try not to take any demands personally. Your former employee is battling for an uncertain future and is terrified of what that future might look like if he or she is out of work for an extended period of time.

Be objective in your assessment of the counteroffer, and if possible, compromise to offer the best package possible to ease the employee’s mind and make a difficult transfer go smoothly.

Employee layoffs are never pleasant, but they are occasionally essential. Even if you must terminate employees on occasion, you may maintain your employer integrity if you provide a well-thought-out, fair severance package that includes all money owed, adequate severance compensation, at least some type of insurance assistance like auto, life or any other, outplacement benefits, and a letter of reference. It’s difficult to make these kinds of business decisions, but if you do everything you can to help your former workers transition, you can sleep easy knowing you did everything you could for them.

How to Calculate Severance Pay

It is entirely up to you how you compute severance pay. Will you provide redundancy pay to all employees that are let go? Or only those in positions of power? Which advantages will you include? Whatever you decide, make it clear in your redundancy and severance policy. You must also ensure that all existing and new workers have access to the policy.

Here is how you can calculate severance pay:

For hourly employees

# of years with company X 1 week of regular pay = Severance pay total

If you typically make $1,000 per week and have worked at your company for 10 years, your severance pay would be $10,000 (10 years X $1,000 = $10,000)

For salaried employees

# of years with company X 2 weeks of regular pay = Severance pay total

If your salary is $100,000 per year, that is $4,000 for two weeks (given the cap is 25 weeks). If you have been at the company for 10 years, your severance pay would be $40,000 ($4,000 X 10 years).

Should you Develop a Severance Package Policy?

Now, we come to the question of whether or not a severance package policy is important. There is no necessity to design a severance compensation policy. Furthermore, if the majority of your employees are on an at-will basis, a specific severance pay policy may not be necessary. However, if you do create a policy, it must be followed consistently and without exception. As experts say, if a company is worried about the exposure of liability and wants to use a severance agreement to mitigate those exposures, that’s a one-off situation.

Companies that choose not to have a severance pay policy can simply draft one-time severance agreements if the need arises. These can be produced on a case-by-case, tailored basis, giving businesses additional flexibility to tailor the conditions to each situation. However, employers need to keep in mind that whatever way they choose, they have to be sure to not use discriminatory factors or appear inconsistent.

Diana Ford

Diana Ford

Diana Ford utilizes over seven years of experience in marketing. She covers some industry-specific topics such as money management and business finance.

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.


Top Trending Posts

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More