Severance Pay

Definition

The term severance pay refers to compensation provided by a company to an individual when their employment has been terminated.  Severance pay may be provided when an employee is laid off, or through a mutual agreement with the company when a decision is made to terminate their employment.

Explanation

Severance pay is a benefit provided to an employee when their job is eliminated or when the company and employee agree it would be mutually beneficial for the employee to resign from the company.  Employees are usually not entitled to this benefit if they were fired due to poor performance, or were found to be in violation of a company policy.

Companies are not required to pay employees severance, the Fair Labor Standards Act (FLSA) does not provide any employee with this benefit.  Severance may be negotiated as part of a collective bargaining agreement.  It may also be part of the company's benefits package offered to all employees.

The amount of compensation paid is typically a function of the employee's years of service; however, a maximum benefit may also apply.  For example, a company may agree to pay 1.5 weeks of an employee's salary for every year of service, up to a maximum of 52 weeks.  Typical benefits range from one-half to two weeks of pay for every year of service.  Executives may be entitled to additional benefits, which are often negotiated as part of their employment contract with their company.

A severance benefit can also include the payment of unused sick or vacation days.  The extension of medical or dental insurance beyond an individual's last day of employment is usually categorized as a termination benefit.  When an employee agrees to accept severance pay, they may be asked to give up their right to file a lawsuit against the employer for wrongful discharge.

Related Terms

dismissal compensation, dislocated worker, exit incentives, workforce reduction