If you're a small business owner and want to offer your employees severance pay, you're doing them a tremendous service. Severance pay gives a terminated employee a month or two to find another position without having to worry about how to pay their bills. While severance pay isn't usually legally required, it's considered a gesture of goodwill that demonstrates no hard feelings towards the employee you had to let go. Generally, you can offer a lump-sum payment or extend paychecks for a specific amount of time. You might include other benefits, such as health insurance, in the severance package as well. The terms of a severance package are typically laid out in a contract that you and the employee sign.
Handing Out Severance Pay
- Provide 1 to 2 weeks of pay for every year of employment. This is the standard formula for severance packages, particularly if you're laying off a long-term employee. If the employee hasn't been working for you for very long, you might consider other options.
- For example, you might decide that your minimum severance pay is 2 weeks, plus 1 week for every year the employee has worked for you. That would ensure that all employees entitled to severance pay get at least 2 weeks.
- In addition to this base pay, you might also include payment for unused accrued leave and partial bonuses.
- Make a lump-sum payment to speed up unemployment benefits. Terminated employees typically aren't eligible for unemployment until they've received their last check from your company. A lump-sum payment can make them eligible to collect unemployment sooner.
- If you want to choose what would be in the employee's best interest, get a rough estimate of how much the employee would make in unemployment over the same period they'd be receiving severance checks. If they'd get more in unemployment, they'd likely be better off if you gave them a lump-sum payment.
- When you give a lump-sum payment, that typically ends other benefits as well. It doesn't have to, though — you're free to structure your severance package however you want.
- Spread out payments if you want to cushion the blow. Technically, this is called "salary continuation," and is as simple as continuing to issue the employee their regular paycheck for an agreed-upon period. Many employees prefer this to a lump-sum because they've already structured their budget around that income.
- When you spread out payments like this, the person is usually still technically considered your employee for unemployment insurance purposes. This can make it difficult for that person to collect unemployment, but, at the same time, they shouldn't need it.
- If you've decided to go with salary continuation, include information in your severance agreement about whether payments continue if the employee finds a new job during the severance period.
- During the salary continuation period, most employers also continue to provide health insurance and other benefits under the same terms as when the employee was working. It's not legally required, though, and you can have the employee pay for it.
- Defer payment of severance if it would put your employee in a higher tax bracket. Look at the current tax brackets, available on the IRS website, and figure out where your employee normally fits in. If making the severance payments would put them in a higher tax bracket, that means they'd have to pay higher taxes. If you hold off until the next calendar year, that might not happen.
- This is something you want to talk to the employee about so they can figure out what's best for them. If they don't have any leads on another position and are thinking it might take them a while to find something else, they may want you to pay the money now, even if they do end up paying more taxes.
Drafting a Severance Agreement
- Format the agreement with numbered paragraphs like a contract. Put your heading at the top (usually "Severance Agreement" or "General Release and Severance Agreement"). Then, organize the document into numbered paragraphs with a double-space between each one. Each paragraph covers only one part of the severance package. Leave lines and space at the end of the agreement for both you and the employee to sign.
- Search for "severance agreement template" to find templates online that you can download for free and adapt to your purposes.
- A severance agreement that's only 2 or 3 paragraphs can often just be written as a basic business letter — no need for an extensive contract format.
- If you have a complex agreement, such as a severance package that involves a lot of money and stock or one in which there is a serious threat of legal liability, it's usually best to have an attorney draw it up for you.
- Identify the parties to the agreement and their relationship. Start your agreement by naming your company and the employee who will be leaving. Include the employee's job title, the date they started working for your company, and when their last day will be.
- At the beginning of your agreement, you can also discuss the reasons for the termination, reinforce that the split is amicable, or emphasize your support for the employee and your commitment to helping them find a new position.
- Outline the total pay included in the severance package. Apart from the basic severance pay, usually 1 or 2 weeks' pay for each year worked, list other amounts you'll pay the employee and what they represent.
- For example, you might pay the employee for paid vacation or sick time that they've accrued but not used yet.
- You might also provide additional money meant to account for the employee's extraordinary contributions or unpaid bonuses.
- Describe what happens to the employee's retirement plan or stock options. Termination changes how employer-based retirement plans and stock options work. Include a detailed accounting of the employee's plan, or explain in the severance agreement how to get that information. Let employees know how to access their plans and what to do with their stock options.
- If the employee has options that have been granted but haven't vested yet, you might negotiate with the employee to accelerate the vesting of those options so they can purchase stock. You might do that in exchange for less cash severance pay.
- Retirement plans and stock options can get complicated in the context of a severance package. Talk to the broker who handles those plans to make sure you get all the details correct.
- Extend health insurance benefits for a month or two. Since most Americans rely on their employers to provide health insurance, these benefits are extremely valuable for a recently terminated employee. With any luck, they'll find another position before their benefits with you end so they don't have any lapse in coverage.
- Some employers also continue life insurance for a set period after termination as part of the severance package.
- Include specific information about the insurance companies that hold the employee's policies and how they can access them or transfer them to another company.
- Offer to help the employee find another position. A terminated employee might not have had to look for a job for a long time, especially if they've worked for your company for a number of years. They might not really know where to start, so offering them assistance can be a real lifesaver. Some ways to help include:
- Writing letters of recommendation
- Providing positive references
- Giving practice interviews
- Holding résumé-writing workshops
- Setting up career counseling services
- Making a list of job leads in the industry
- Add extensions of other perks your employees enjoy to sweeten the pot. If you offer other perks to your employees, such as free mobile phones or gym memberships, letting a terminated employee keep these is a nice gesture that likely won't cost you much. Talk to your employees and find out which small perks they use most often or value the most.
- For example, if parking downtown is expensive and you have free parking for employees, you might let terminated employees hang onto their parking passes until they find other employment. That free parking would help a lot if they had to be downtown frequently for job interviews.
- Include non-compete or Write a Non Disclosure Agreement (NDA) clauses you feel are necessary. In the context of a severance agreement, a non-disclosure clause typically prohibits the employee from discussing the terms of their severance package with anyone else. Noncompete clauses, on the other hand, typically restrict the terminated employee from working for any of your closest competitors for a specific period after leaving your company.
- Noncompete agreements can also be used to protect your client lists or proprietary data. For example, you might prohibit the employee from soliciting any of their previous clients to follow them to their new company.
- If you decide you want a noncompete clause, it's best to have an attorney draft it. While they're usually allowed, courts have a dim view of them and they're easy to challenge — especially as part of a severance package — because they can restrict the terminated employee from working in the field they know best.
- Write a standard release to keep the terminated employee from suing you. A common release in a severance agreement would state that in exchange for the compensation listed in the agreement, the terminated employee agrees to "release the company and its agents from any and all claims and liabilities, known and unknown." Essentially, the terminated employee waives their rights to sue you or your company for any reason related to their employment.
- To make the release more palatable, you might start it with a statement that you don't anticipate any lawsuits and have a good relationship with the terminated employee. Then, transition into standard release language.
- Most employees don't have any problem with these releases, and it protects your company from potential liability.
- Close by laying out the consequences of violating the agreement. Once you and your employee sign the severance agreement, you are both contractually bound to follow its terms. If your employee violates the terms of the agreement, you can sue them for breach of contract. Likewise, they have the right to sue you if you fail to uphold your end of the bargain.
- Typically, these provisions define what constitutes a breach of the contract and enables either party to sue, as well as stating where that lawsuit can be brought.
- If you're using a template for your agreement, it likely includes provisions on breach of contract. Read through them and make sure you understand them and that they work for you. For example, if your template states that any lawsuit would be brought in a Texas court and your business is located in California, you would want to change that location.
- If you have questions about severance payment laws in your state or the components of your severance package, talk to an attorney who specializes in employment law.
- If you aren't planning on offering the same severance package to all employees, make it clear in your employee handbook and in the severance agreement that severance pay is not guaranteed and entirely in your discretion.
- Severance pay is considered compensation and subject to the same tax withholding as the employee's regular pay.
- This article discusses how to pay severance in the US. If you live in another country, different policies and procedures might apply. Talk to a local payroll or human resources expert.
- For your own protection, always put severance agreements in writing.