What is 'Severance Pay'

Severance pay is the compensation an employer provides to an employee who has been laid off, whose job has been eliminated, who has decided to leave the company through mutual agreement, or who has parted ways with the company for other reasons. In addition to pay, severance packages can include extended benefits, such as health insurance and outplacement assistance, to help an employee secure a new position.

BREAKING DOWN 'Severance Pay'

Severance pay is not provided by all companies, and businesses typically issue severance pay on a case-by-case basis and as dictated by any employment contracts. For example, when Superintendent Stan Rounds agreed to resign from the La Cruces Public Schools, the New Mexico Public Education Department and the Third Judicial District Court had to approve his $140,000 severance package to ensure it met state guidelines and Education Board expectations. As he had one year left on his contract when he agreed to resign, his severance package may represent his annual compensation.

In contrast, when businesses fail to offer severance packages, it can upset staff and create negative public relations. To illustrate, when the Four Seasons closed in 2016, it only offered its displaced employees a total of $500,000. Severance payments for front-of-house staff were as low as $600, regardless of how long the employees were with the company. This was a move that attracted much criticism.

Do Businesses Have to Offer Severance Pay?

No law requires employers to provide severance pay. However, if the employee's contract stipulates he receives severance pay upon dismissal or if the employee handbook promises severance pay, the company is legally obligated to follow through with those pledges. Additionally, if the company makes a verbal promise to provide an employee with severance pay, it must also uphold that agreement.

Regardless of whether a company offers severance pay, the Fair Labor Standards Act (FLSA) mandates an employer must pay the employee who has been terminated through his last day of work, and the employer must also pay any vacation time the employee has accrued.

Does Severance Pay Affect Unemployment Benefits?

Severance pay can affect unemployment compensation in two distinct ways. If the employer pays the employee severance fee in a lump sum, the employee can apply for unemployment insurance right away as he is no longer on the company's payroll. However, in some cases, companies issue severance pay over a period of several months, and through that process, the employee is still technically on the payroll, even if he does not go to work. As a result, he cannot apply for unemployment. Similarly, if an employee has unused vacation time, he is on the payroll as he uses it.

In other cases, severance pay affects unemployment compensation because of the contracts many people sign when they accept severance pay. In exchange for offering severance packages, some companies make their employees sign statements saying they voluntarily resigned from their posts. These agreements prohibit the employee from claiming unemployment insurance, as it is reserved for people who are dismissed from their jobs involuntarily.

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