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An Employer's Guide to Severance Plans

Severance plans are generally designed to provide financial support to employees who lose their jobs through no fault of their own. Benefits offered through a plan can help the employee weather the period of unemployment following a termination or layoff, and to some extent compensate the employee for the loss of seniority and other privileges or rights the employee may have enjoyed in his or her position.

Should You Adopt a Formal Severance Plan or Policy?

There is no requirement to offer severance pay under federal law. The reasons an employer might choose to offer severance vary, and an employer may design one or more plans to meet specific needs.
  • An employer may wish to provide severance to a specific group of employees (such as executives) who will be displaced because of some anticipated event, such as an upcoming merger or acquisition. That plan may simply be a contractual agreement individualized for each employee, or it could be structured more formally.
  • An employer who is implementing an extensive reduction in force (RIF) may wish to adopt a plan specifically geared to address the persons losing their jobs as a result of the RIF, though there is no obligation to do so.
  • Sometimes an employer will offer severance pay in exchange for the departing employee's signing a release and waiver of liability releasing the employer from claims of discrimination, breach of contract, wrongful discharge or the like, in connection with a termination or reduction in force.*
  • Still other employers develop a company-wide severance plan to provide a sense of security for both prospective and current employees in the event of unexpected job loss.
Before you implement any type of severance plan, you need to give careful thought to its structure. You should also be aware that your plan may be covered by the Employee Retirement Income Security Act (ERISA), in which case you will be obligated to provide summary plan descriptions to employees and may have some reporting obligations to the U.S. Department of Labor.  If you already have benefits such as a 401(k) plan in place, you may already be familiar with some of these requirements.

*Note: A severance agreement for any employee over the age of 40 must comply with the Older Workers Benefits Protection Act (OWBPA), which requires a number of specific provisions in the agreement and sets forth specific standards that must be met in any release in order to be effective as to age discrimination claims. Among other things, the employee must have 21 days to decide to execute the agreement and then an additional seven days in which to rescind it. The employee must also be invited to seek legal counsel regarding the matter. Absent those provisions, any waiver of age discrimination claims is void.

Considerations in Adopting Your Severance Plan

Who will be covered?

An employer may choose to provide severance benefits for all employees, from hourly paid workers to executives. Alternatively, severance benefits may be offered only to certain groups of employees, such as managers and executives.  Severance benefits need not be the same among all groups of employees, for example, granting them to exempt employees and not to non-exempt, so long as the plan does not discriminate against any employee or group of employees based upon race, sex, age, color, national origin, or any other legally protected class.

What benefits will you offer?

Severance plans vary widely, but employers commonly pay severance based on an equation which considers the employee's compensation at the time of termination and the length of the employee's service with the employer–for example, one to two weeks' pay for each year of service (with predetermined minimums and maximums). Other companies multiply an employee's monthly pay times a certain number of months, typically one to three months. Severance payments may be made in one lump sum, or gradually with regular payroll periods. 

Other factors considered by employers in determining the benefits of a plan include seniority, compensation level and coordination with other benefits.
  • In plans considering seniority, a typical formula multiplies the employee's pay by a number of weeks, months or pay periods covered by the policy times a seniority factor.  For example, an employer might give everyone one month of severance, but add on additional weeks for each six months or each year of service after the employee's first year of employment.
  • Employers may consider the compensation level of each employee in setting severance pay levels and may also consider other benefits such as unemployment compensation as a set off.
Be sure to consider that severance paid to involuntarily terminated employees is subject to federal income, Social Security and Medicare, and federal unemployment taxes.  State taxes such as workers' compensation and other withholding requirements may also apply.

 

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