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Severance Pay - What You Should Know

RetirementJobs.com Staff Writers

Every year, millions of people lose their jobs. If they were fortunate, they may have been offered a severance package by their employer.

Severance pay is best described as an employer voluntarily offering payment to a worker who has been terminated or whose job has been eliminated.

I hope you never have to deal with severance pay. But if you do, here's what you need to know and what things you should consider before accepting a severance agreement.

Why Offer Severance Pay?
Slightly less than 50% of employers provide some amount of severance pay to workers whose employment is terminated. Except in those cases where an employment contract, union agreement or a preexisting employer policy requires or provides for severance pay, there is no law or regulation requiring any company to offer severance.

Employers voluntarily choose to provide severance to insure goodwill with current, past, and future employees. These employers generally consider the severance pay to be a sort of voluntary supplemental unemployment compensation. Employers recognize the reality that unemployment compensation, even in the most generous states, is usually far less than half of a worker's salary .Severance pay can alleviate some financial hardship in the short term.

Employers also use severance pay to enforce a "release from liability" or waiver from lawsuits for improper or discriminatory termination. In most cases, an employer will require a departing employee to sign a release before paying out severance. These releases help employers reduce the possibility of legal action by terminated employees. In fact, it may be to your benefit that an employer requires a liability release because it may affect your eligibility and amount of unemployment compensation.

What's Included in Severance?
Large employers often have established and formal severance pay policies which are based on a formula factoring in length of service, pay level, and job category. Once established and paid to employees, such severance policies become almost de facto commitments though even these can be withdrawn unilaterally. For example, an employer may offer one week's pay for every year of service. Executive severance is often covered by an employment agreement, and is typically more generous. One month pay for each year of service to a stated maximum amount is not unusual.

A severance package may also include continuation of health and life insurance benefits. Employers may elect to allow a terminated employee to continue paying "active employee" premiums or offer only COBRA health benefit continuation. Occasionally, employers may also offer job search or "outplacement" services.

Small to mid-size employers will tend to rely on informal severance pay or, they may also elect to not pay any severance. Don't confuse severance pay with pay in lieu of notice or the payment of accrued vacation days at termination (required in all states). States vary in their consideration of accrued vacation pay but in general, the lump sum vacation payout may affect only your first week of unemployment compensation.

Lump Sum or Payments?
Employers may elect to pay severance as a lump sum upon termination and completion of a liability release agreement. More likely, they will provide periodic payment, essentially making severance payments on a payroll cycle. Getting paid in this manner may help with maintaining a sense of normalcy to your income, but it can result in a loss of eligibility for unemployment compensation or a reduction in unemployment payment. The good news is that ongoing periodic payments are often accompanied by health benefit continuation on favorable terms.

Employers will often base their decision of providing lump sum versus periodic payments on the unemployment compensation laws of the employee's state of residence. In some states, workers are not eligible for unemployment payments if they are receiving ongoing periodic income from a severance. So a person may need to wait to file for unemployment until the employer is finished paying out the severance. Paying out severance in this fashion helps employers avoid or reduce unemployment claims charged to their record and as a result, prevent their unemployment compensation premiums from increasing.

If you accept the severance agreement, I would recommend filing for unemployment compensation immediately and let the state officials sort out your eligibility. You can always appeal an unfavorable decision.

Unemployment and Severance Pay
This will frustrate you, but whether severance pay affects your unemployment benefits is based on the state where you live. In California, severance pay, whether lump sum or periodic, never affects unemployment benefits. In Michigan, ongoing periodic payments or a lump sum that an employer "allocates" over a specific period in its reporting to the State reduces unemployment benefits for every week in which there is an allocation assigned. Massachusetts will also reduce unemployment benefits in weeks you receive a severance payment but will not if you were required to sign a release of liability.

Your best course of action is to contact the state agency that manages unemployment compensation and review your state's rules. You can do this online as well by searching "severance pay and unemployment compensation".

Do I Need an Attorney?
If offered severance pay with a required release of liability, your employer is obligated to suggest you seek independent legal counsel. Unless you're a highly-paid executive with a complex employment agreement and severance package worth a large sum, an attorney is not cost justified.Read the agreement, talk with colleagues, and ask the human resources department for interpretation and clarification. Employers are also required to grant you a "cooling off" period after you sign in case you change your mind and decide not to accept the terms of the severance agreement.

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