Severance Pay Benefit Employees When They Are Fired
Whether it’s due to downsizing, a restructure or even a company’s decision to close up shop, firing employees can be stressful for both parties. But a well-written severance pay plan can help make the transition as smooth as possible for both sides.
Severance pay is compensation that companies pay to terminated employees after they leave their job, typically in addition to the employee’s final paycheck. It can include a lump sum or a series of payments following a set schedule. Severance packages usually take into account factors like the number of years the employee worked for the company, seniority and job title. In some states, employers are required to compensate terminated employees for unused vacation or sick time.
In many cases, severance pay is considered income taxable. That’s because the money can be used to cover a financial gap until the former employee finds a new job. Depending on the amount, some severance packages also include outplacement services to help them find another role. In that case, the payments could be considered a salary continuation and subject to the same withholding rates that apply to regular employment income.
How Does Severance Pay Benefit Employees When They Are Fired?
The specific terms of severance packages vary widely by company. Some have a standard formula that’s based on the number of years the employee worked for the employer, including a week’s pay for each year of service and a bonus of two weeks for each year over 10. Other companies might use different formulas or create their own unique plans.
Aside from the payment itself, severance retiring allowance can include a variety of other benefits. These can range from continued insurance coverage to career consultation services, a payout of unused vacation and sick time and the option to keep company equipment such as cell phones. The amount and type of benefits offered by a company can also reflect the culture and values of its management.
Some companies may be reluctant to offer severance packages to employees who have been fired for cause. Others will be more open to it. “A company that’s worried about a departing employee filing a lawsuit might be more willing to offer a lot,” Clark says. “On the other hand, a company that has a culture of being friendly with its employees might be more willing to offer less.”
Depending on how severance payments are structured, they may be considered taxable as income in the year they’re received or treated as a retiring allowance at the time of termination. In the latter case, the retirement allowance is taxed at a worker’s normal withholding rate based on their W-4, and the deductions from the pay that go to federal, state and Social Security taxes also apply. A tax adviser can help workers determine the appropriate way to structure their severance packages so they’re most beneficial to them.