Guide to Severance Pay

Losing a job, especially one you loved, can be painful and difficult. If you were recently let go for no fault of your own, you may be offered severance pay. If you’re encountering the topic of severance pay for the first time, you may have questions, like:

  • What is severance pay?
  • How does severance pay work?
  • Will severance affect unemployment?

In this guide, we will explain what severance pay is and the elements a severance agreement might include. Although this may be a stressful time, understanding your severance pay can help you successfully move toward recovering from sudden job loss.

What is severance pay?

Severance pay is a payment package an employer offers to an employee who is discharged from service. The conditions for receiving a severance package often involve an involuntary layoff of the employee for any number of reasons.

For example, if your company was recently acquired by another business, there may be duplicated responsibilities as the two teams merge. As a result, layoffs may be required to eliminate extraneous roles. A company may also decide to switch to a new automated technology that may put the jobs of certain groups of employees at risk.

Whatever the reason, if you do receive severance, it will likely be offered during a meeting between you and a Human Resources representative or manager. Your severance may either be a result of your employment contract or a goodwill gesture from your company as you transition into unemployment and back onto the job market.

How does severance pay work?

When you receive your layoff notice, your employer may offer you severance as a result. Severance pay varies by company, but the process may work like this:

  1. The employer notifies the employee of a coming layoff.
  2. The employer schedules a meeting with the employee to discuss the next steps.
  3. The employer offers a severance package, often contingent upon signing a “severance agreement.”
  4. The employee may or may not try to negotiate for a higher severance package, depending on the company.
  5. Upon signing the severance agreement, the employee will receive a severance package in the form of a one-time payment or multiple payments over the course of a specified number of months. Severance packages may also include a continuation of benefits, such as health insurance or other forms of payment that are agreed upon and formalized in the severance agreement.

This may not be the exact process for you, as each company handles severance differently. However, if your company does offer severance, some of those steps may be involved.

What is a severance agreement?

A severance agreement is a binding contract that outlines benefits you will receive after your last day, along with any rules or outlines you will be asked to follow upon leaving the company. While each company’s process is unique, severance agreements often also include the length of time you’ll receive those benefits.

A severance agreement may also come with certain restrictions or rules. For example, as part of receiving a severance package, your company may require you to wait a set period of time before applying for work with competitors (often known as a Noncompete Agreement).

There is no legal requirement for companies to provide a severance package, and there is no legal requirement for you to sign it. Nevertheless, if a severance agreement is formalized through signed documents, it does become a legal document by which both parties must abide.

If your company asks you to accept a severance agreement without formal documentation, be sure that you ask for the agreement in writing.

Is severance pay taxable?

Regardless of how much you receive in severance pay, it will be taxed. Any additional compensation you receive from unused vacation time or sick leave is also taxable.

For more information on severance pay taxes, view this IRS document (PDF) on the tax impact of job loss.

Severance pay and unemployment

Whether or not severance pay will affect your unemployment benefits options depends on your state laws.

In Maryland, for example, you cannot claim unemployment benefits during the time period you’re receiving severance pay. If you receive a lump sum severance check, the Maryland Department of Labor also determines a set time before you can apply for unemployment.

In New Jersey, however, you can still receive unemployment even if you get severance pay. The only stipulation is that your severance package must not extend your employment with the company.

Check with your state’s unemployment benefits office to determine the full extent a severance package will have on your potential for unemployment benefits.

Calculating severance pay

A typical severance package may calculate compensation based on the length of time you’ve been employed by the company. One method for this is to give one or two week’s pay for every year of service to the company. So if you’ve been employed for 5 years, for example, you could receive anywhere from 5 to 10 weeks of severance pay.

While this is a common practice for calculating severance, there is no set standard and companies will determine their own methods as they see fit.

What is the average severance pay?

Every severance agreement is a unique document between an individual employee and the company that hired them. How much you receive will be based on your company’s severance policies. However, while 97 percent of businesses in the US claim to have a severance policy in place, only 55 percent of businesses state that they have a written policy. If your company does not have a written policy, you may have the option to negotiate your severance.

How to negotiate severance

If your employer already has written policies in place, especially those that you signed when you accepted the job, the option for severance package negotiation may be unavailable.

However, if your company has no written policy, you may have the option to negotiate. Consider the following practices when preparing to negotiate your severance package:

  • Gather relevant information regarding your length of employment, past rewards for successful service, current earnings, and any other relevant information necessary to exhibit your value to the company.
  • Go into the severance agreement meeting with a calm but confident demeanor. Exhibiting anger during the meeting may have negative results.
  • Once the severance package is offered, look for any areas where the package might be increased. For example, ensure it includes payment for unused paid time off.
  • Once the HR representative or manager has delivered the entire package in detail, ask if the package can be increased. If there’s a Noncompete Agreement or Clause in the package, you may be able to use that as leverage to get the package amount increased. Remember, you are not legally required to sign a severance package.
  • If the company is unwilling to offer a larger amount in severance, ask if you can receive an extension of benefits.
  • If your request is denied, politely accept and move on. Treat the conversation with sensitivity while maintaining confidence in what you need from the company.

If you do successfully negotiate for more severance pay or an extension of severance in your package, be sure to get the agreement in writing as soon as possible.

Severance pay laws

While severance pay laws tend to vary, your state may have laws defining what severance pay is and protecting severance pay agreements as legal documents. Check with your state’s unemployment department to determine if there are any severance pay laws where you work.

Please note: The information on in this article is provided as a courtesy. Indeed is not a career or legal advisor.

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