Letting someone go is never easy, for them or for you. Whether it’s due to downsizing, restructuring, or a role becoming obsolete, part of handling terminations responsibly involves understanding severance pay.
As an HR professional or employer, severance is more than just cutting a check. It’s about legal compliance, brand reputation, and employee relations. Mishandling severance can lead to a non-compliant payroll situation, opening the door to legal and financial risks. This guide breaks down what severance pay is, how it works, when you’re required to offer it (and when you’re not), and how to handle it smartly, both for your business and your people.
What Is Severance Pay?
Severance pay is a financial benefit an employer may offer to an employee upon termination, typically when the termination is not performance-related, like in cases of layoffs, department closures, or company downsizing.
It’s not legally required in all cases, but it can be a strategic tool to:
- Smooth the transition for the departing employee,
- Reduce the risk of legal claims, and
- Protect the company’s reputation.
Example:
An employee who’s worked with your company for 6 years is laid off due to restructuring. You may choose to offer 6 weeks of pay to help them transition. This isn’t a legal mandate, but it can be a wise gesture that builds goodwill and avoids potential backlash.
Severance is separate from final wages or unused PTO payouts, which are legally mandated in many states or countries.
How Severance Pay Typically Works
As an employer, you have several options in structuring a severance package. There’s no universal standard, but consistency, clarity, and documentation are key.
1. Payment Format
- Lump sum: One-time payment that closes the books quickly.
- Installments: Paid over time, sometimes with continued benefits coverage during the period.
2. Formula Based on Tenure
- Common practice: One or two weeks’ pay per year of service.
- For higher-level positions, packages may include more generous terms (salary continuation, extended benefits, or outplacement services).
3. Attached Conditions
A severance agreement often includes:
- A release of claims (critical to reduce legal risk),
- Confidentiality or non-disparagement clauses,
- Possible non-compete or non-solicitation terms.
Make sure the terms are clear, legally sound, and mutually understood.
Is Severance Pay Legally Required?
In most cases, no. U.S. federal law does not require severance pay unless it’s contractually or policy-bound. However, you may be obligated to provide it in the following cases:
You must provide severance if:
- It’s included in an individual employment contract,
- Mandated by a union agreement,
- Promised explicitly in a written policy or employee handbook,
- Required under state or international labor laws (this varies widely).
You’re not required to provide severance if:
- The employee is at-will, and no formal agreement or policy mandates severance,
- They are terminated for cause (e.g., policy violations, misconduct),
- There’s no precedent or documented promise of severance.
That said, just because it’s optional doesn’t mean it’s unnecessary. In many cases, it’s a calculated business decision.
Why Offer Severance Even When You’re Not Legally Required?
Think long-term. Offering severance, even when not required, can:
- Reduce the risk of wrongful termination claims,
- Maintain a positive company image,
- Foster better morale among remaining employees,
- Provide leverage in negotiating non-competes or waivers,
- Show that your company handles layoffs with empathy and professionalism.
If you operate in a competitive industry or a tight labor market, how you treat departing employees sends a strong signal to both current staff and future talent.
Tips for Structuring Severance Packages the Right Way
- Document everything. If you’re offering severance, always draft a formal agreement signed by both parties.
- Keep it consistent. Ad hoc packages can lead to discrimination claims. Have a policy, or at least a framework.
- Consult legal counsel. Especially when offering waivers or restrictive covenants (like non-competes).
- Be transparent. Clearly communicate terms and expectations to the employee. Avoid vague promises.
And remember: Do not confuse severance with an obligation to reward underperformance. Severance is situational, not sentimental.
Consider Global Differences
If you operate internationally, note that severance laws vary drastically by country. For example:
- In Canada, severance is often legally required and calculated based on tenure.
- In many European Union countries, it’s mandatory depending on the reason and type of termination.
- In the U.S., it’s more discretionary, but still carries strategic importance.
If you have remote or global teams, understand the specific laws in their location before finalizing any layoff strategy.
Conclusion: Severance as a Strategic HR Tool
At the end of the day, severance pay isn’t just about being “nice”, it’s about being smart. Whether you’re protecting your company from litigation, preserving your reputation, or keeping morale steady among remaining staff, a well-structured severance policy is a proactive business move.
Investing in payroll training online can also help your HR and finance teams stay up to date with best practices and legal obligations around severance, ensuring consistency and compliance.
If you don’t already have a policy in place, now’s the time to create one. If you do, review it. Make sure it’s relevant, fair, and legally defensible.
Because when layoffs happen (and they do), the way you handle them matters. Not just to the person leaving, but to every person still watching.
