How Does Severance Pay Work?

woman who's been laid off


Connie Wedel
Connie Wedel

What Is a Severance Pay?

Severance pay is payment granted to an employee at the termination of employment in association with a severance agreement. 
Often severance payment or a severance package is offered when an employer initiates the separation, such as:
  • in a layoff or other types of involuntary terminations, 
  • in exchange for an agreement not to litigate, or 
  • as part of the buyout of some employment contract terms. 
Employers are not required by the Federal Labor Standards Act (FLSA) to offer severance pay. On a case-by-case basis, other agreements, contracts, policies or company precedent may trigger an obligation to pay severance. 
There are several potential reasons why employees may be offered severance pay. The altruistic reasons are to help you bridge the financial gap until you find a new job. Other goodwill reasons include helping you prepare for your pending job search or to increase your skills by paying for outplacement or training services. 
Know that severance practices vary company by company. Payment amounts will also vary and are often tied to the length of service and position level. 

How does severance pay work?

Be aware that with a severance package offer, you will usually be given a “Separation Agreement” as well. Paying out your severance will be contingent on signing the separation agreement. You will be given a specific amount of time to review and then sign the separation agreement before the offer of severance payment is paid out or withdrawn. 
If you sign the separation agreement, you will release your employer from future potential legal claims or disputes as described in the agreement. The agreement may also contain confidentiality, non-compete and non-disclosure clauses. 
This is a common corporate practice so do not be alarmed if you are given separation agreement. Since employment laws differ across various states and localities, companies will usually have an employment attorney draft and update their separation agreements based on your state’s and federal employment laws. 
It is important that you timely and thoroughly read the severance agreement. You also have the right to have an attorney review it. You do not have to have an attorney review, but depending on your personal situation or the background behind your separation, you should carefully consider this option before you sign. 

Who gets severance pay?

In short, severance pay is granted to employees who are terminated — usually involuntarily — after they have signed a separation agreement. 

Is my severance package negotiable?

Maybe, maybe not. Some companies will be steadfast in their offer, but others will be more willing to negotiate, just as some employers were more willing to negotiate your wages in the first place. Just like an offer of employment, a separation package can be up for negotiation. You should explore this option to see if you can negotiate components of the separation agreement. Based on your personal situation, some items in the package you may want to consider to either add or negotiate are:
1. Money – (severance amount / monetary payout)
2. Payment terms - (lump sum or over time)
3. Payment of continued health benefits - (COBRA)
4. Retaining company equipment such as phone, computer
5. Not contesting unemployment benefits (more important if you are released for performance or misconduct)
6. Outplacement services 
7. Resume and social media services
8. Letters of reference
9. Previously-agreed upon benefits (such as tuition reimbursement, training)
10. Loan repayment terms – if applicable
11. Commission, bonuses and deferred compensation payouts due 
12. Rights under pension, profit sharing and 401(k) plans 
13. Stock, equity, options and exercise schedule

14. Employee length of service
Even if you are leaving by your own choice by accepting an employee buyout plan, for example, you will have mixed emotions about leaving behind your job and going to someplace new. If it’s not your choice, your emotional state and anxiety level will be even higher. This is the time to think about your finances and budget, as well as keep a level head and search out knowledgeable and supportive advice. Your goal should be to work with your ex-employer to agree on a fair and (as generous as possible) severance package that will help you until you land your next job.

Is severance pay taxable?

Yes. According to the Supreme Court, severance pay is taxable as income. That means that it is responsible for payroll tax, Social Security tax and Medicare tax. 

Does severance pay affect unemployment eligibility? 

Depending on your state unemployment rules, often times you cannot both collect severance pay and unemployment insurance benefits at the same time. Even if your severance payment occurred in one lump sum, this may push out the effective date at which you can collect unemployment insurance. For example, if you were paid the equivalent of three months of wages in a lump-sum payment under your severance plan, your unemployment benefit may be reduced by three months and may not begin to be paid out until after three months after the date of your lump sum payment.

Disclaimer: The material contained in this article was written for informational purposes only and is not legal advice. You should contact your attorney to obtain advice with respect to your particular situation, issue or problem. Unemployment compensation benefit law and unemployment insurance terms vary widely and are governed by your state and local laws.

About the Career Expert:

Connie Wedel is a global citizen and HR executive who has worked with incredible employees, teams and leaders across 6 continents. Connie is a leadership and career coach, equal rights and diversity advocate, writer, speaker and mom.