As a small business owner, you may consider providing severance pay for employees. But what is it exactly, how does it work?
Here's what you need to know:
- Severance pay is not required by law
- Companies consider offering severance when the termination is beyond the employee's control (examples: downsizing, change in management)
- For upper management, severance is generally equal to a month’s salary for every year on the job
- For mid- to entry-level employees, it can usual amount to 1 or 2 weeks pay per year on the job
When a business has to let go of staff for reasons outside the employee’s control, many organizations consider offering severance pay or a severance package to conclude the relationship. Though the practice is most commonly used when upper management is relieved of their duties, severance can be beneficial to all levels of employees and to businesses of all sizes.
Severance pay is not required by law. For businesses that provide severance, there are a variety of ways to offer it to staff members. Severance pay can be just that — a specific lump sum amount paid out one time to an employee when they leave.
But many companies provide more than monetary compensation. An extension of health benefits could be important for employees as they find the right provider through the Affordable Care Act or other means. Assistance finding another job can be another benefit provided for departing staffers.
For businesses that provide severance in the form of salary, the range of options varies. For upper management, severance is generally equal to a month’s salary for every year on the job. For mid- to entry-level employees, it can usual amount to 1 or 2 weeks pay per year on the job. Another common option is just providing 1 or 2 weeks total pay, regardless of tenure or title.
If benefits are of a larger concern to the departing employee, some companies offer severance in the form of benefits contributions. Rather than providing the employee with their COBRA notification and payment schedule on separation, the company offers to keep the employee on their benefits plan for a set amount of time and/or until the employee is able to secure other coverage.
If you are offering only health coverage under a severance package, remember the employee will not be making their payroll contribution to the plan. The company will need to cover their portion.
Another option is to offer separated employees assistance with finding a new job. Career counselors or outplacement services agencies may be provided for a specific length of time to help with the transition.
General release severance agreement
An important aspect of severance packages or payments is the opportunity to secure a general release from the employee. These contracts affirm that in exchange for the severance payment and/or package, the employee will not sue the company for any reason.
These agreements may also include prohibitions on the employee from making disparaging comments about the company, and in some states, can include non-compete clauses.
If you’re providing severance in any form, a general release is an important component. In most states, an employee has 21 days to review the agreement before signing it, and another 7 days to revoke their signature. There are templates available online, but make sure any agreement is reviewed by an attorney to ensure that all its clauses are valid in your state or jurisdiction.
A severance example
Joan, a single mother with teenage children, has been a reliable worker for 5 years, but a recent consolidation of workload has made her redundant. No other jobs in the company are suitable for her skill set. XYZ Company is considering a severance package to ease her transition.
Several options are available and discussed with Joan to determine which is the best choice for her needs:
- A lump sum payment is one option. In many cases, businesses provide a standard 2 weeks severance payment
- Another choice may be to offer Joan 2 weeks for every year on the job, or 10 weeks salary in a lump sum payout
- Still another choice may be 1 weeks salary for every year on the job, plus a 5-week extension of health benefits for her and her children
- Or, the company might offer no wages, and instead just provide a continuation of health benefits, paid by the company
- Outplacement services may also be provided.
If you’re willing to provide options to the employee, these examples can be a starting point, while other choices may be right for your company and employees. Be willing to negotiate your severance. Employees, leveraging their willingness to sign a general release on separation, have some advantage here. You’ll want to be ready to counter any offer they make with a reasonable alternative.
Joan requests to stay on the company payroll for 8 weeks to keep her health benefits. She will continue to make her portion of healthcare contributions through payroll deductions. Joan signs the general release and agrees to notify the company if she obtains other healthcare coverage so they can remove her from their plan.
Creating a severance policy
A best practice is to set a severance policy well in advance. The benefits can be twofold. First, employees will know what they can expect. Second, severance can be provided evenly and fairly, avoiding even the appearance of discrimination.
A severance policy should plainly state which employees are eligible. This typically includes only employees who are terminated without cause. Those staff members who did not violate any company policy nor perform their work in a substandard manner would be eligible. Businesses may want to clearly state that employees who are laid off, resign, or those who are terminated for cause will not be eligible for severance.
Your policy should also outline what type of payment, services or continuation of benefits an employee can anticipate. Your policy may mention that employees have options and list the types of payments or services available to them. Once established, you’ll want to adhere to these guidelines to assure fairness and equity.
Why provide severance?
In addition to the opportunity for businesses to avoid potential lawsuits or claims with a general release, severance packages are gestures of goodwill. They demonstrate that an employee was valued on the job.
If you have to let go of a good employee who you might want to recruit back in the future, proving a severance package can be a great way to maintain the possibility of bringing them back some day.