What Is a Severance Package? Meaning, Purpose, and Benefits

What Is a Severance Package?

A severance package is a compensation bundle awarded to an employee upon being laid off from a company. The value of the severance package is usually based on the length of employment prior to termination. The receipt of a severance package is contingent upon signing a severance agreement.

Understanding Severance Packages

Overall, a severance package serves as a form of acknowledgment from the employer of the employee's contributions to the company and helps mitigate the financial impact of sudden job loss. It's awarded under circumstances where the employee hasn't left voluntarily but instead has been let go by the company unrelated to performance issues.

It's possible to negotiate your severance package. However, the negotiation and implementation of severance packages can involve complex legal considerations and may be difficult to pull off. These considerations range from compliance with employment laws, contract terms, and potential disputes over entitlements. In many ways, a severance package is dictated by the company with the departing employee have little to no say in the award.

Types of Severance Packages

There are all sorts of severance packages. The exact package is dictated by company policy, and some types of severance packages can include a combination of:

• Lump Sum Payment: A one-time, fixed amount paid to the departing employee upon termination.
• Salary Continuation: A received regular salary payment for a specified period following termination.
• Benefits Continuation: A continuation of certain employee benefits such as health insurance, dental coverage, or retirement contributions.
• Outplacement Services: Access to career counseling, job search assistance, resume writing services, and interview coaching to help departing employees find new employment opportunities.
• Stock Options or Equity: Accelerated vesting of stock options or equity grants allowing them to retain ownership of company stock or participate in future gains.
• Performance Bonuses: A prorated performance bonus or other incentive compensation earned prior to termination.

How Severance Packages Are Determined

An employee handbook typically includes information on a company's severance package policy. Keep in mind, however, that the handbook may need to be updated, and that severance packages are negotiable. Companies are not required to offer a severance package and, in fact, may not be able to offer one if they are letting employees go because they are in major financial trouble.

With many employees hired on an at-will basis, companies typically are not contractually required to provide severance packages when they are laid off or terminated. If a severance package is offered, the scope of what is offered can vary by company. Some companies might offer pay at a flat rate for all separated workers regardless of the length of their employment. Other companies might create a scale for payment based on the duration of their employment with the company. Even if a company does offer a severance package, there may be circumstances, such as a termination for cause, when such compensation is withheld.

The size of severance packages and what they include may be part of the negotiations between companies and collective bargaining organizations. For instance, a union might demand a certain minimum payout with severance packages in order to help members who lose their jobs and must seek new employment. This can be of particular concern in industries where mass layoffs are possible and can affect entire divisions or a category of employees, such as factory workers.

Perception of Severance Packages

It'd be remiss to not touch on the perception of severance packages as a goodwill measure of a company. The perception and impact of severance packages extend beyond the individual employee to affect organizational culture, employer branding, employee engagement, or company morale. Companies that offer robust and compassionate severance packages may enhance their reputation as socially responsible employers. This may attract talent in the long run.

In a similar manner, employees aware of their company's severance package policy may find solace in knowing what may await them should the company encounter difficult times. Though no severance package is ever guaranteed, the perception of a severance package may dictate whether or not an employee is willing to ride it out with a company and risk a future layoff (knowing there may be future benefits to help them during the transition).

Limitations of Severance Packages

There are some downsides to getting a severance package (aside from the fact that this signals you are being let go). As nice as it is to get compensation for your transition, severance packages may not always provide the sufficient financial resources you need while you don't have a job. This may be especially true for short-time or entry-level staff being let go.

Not all employees may be eligible for severance packages. For example, employees terminated for cause, those who voluntarily resign, or those employed on a temporary or contract basis may not qualify for severance benefits. Therefore, be mindful of situations where you expect a severance package but wouldn't be awarded one. In addition, though it's possible to negotiate a severance package, employees will be severely limited in their bargaining power.

Another important consideration is that severance pay may be subject to taxation. Because you may receive something in a lump sum, it may be possible for you to be bumped to a higher tax margin based on receiving more compensation in a smaller time period.

Last, in order to get your severance package, you may have to agree to certain conditions. Severance agreements often include legal provisions such as non-compete clauses or waivers of claims which may restrict the employee's ability to pursue other opportunities or legal remedies.

The Bottom Line

Severance packages are compensation awards provided to employees who are involuntarily terminated from their jobs. The packages can include financial benefits, continuation of certain benefits, and sometimes additional services like outplacement assistance. Severance packages aim to provide departing employees with a little bit of security during the transition period when they are looking for a new job.