While companies are not required by federal law to provide severance pay to terminated employees, many voluntarily choose to do so. This brings up a crucial question for HR experts: How is severance pay determined?
Providing departing employees with a financial cushion of course helps smooth these workers’ transitions to new jobs, but the practice benefits the company too. Severance pay helps organizations maintain more positive relationships with departing employees, thereby protecting employer brand and forestalling litigation. If a company does not provide severance pay, other costs often go up due to a higher cost-per-hire, an increased number of wrongful termination claims, and a shrinking customer base. In some cases, employees who haven’t been provided with severance pay have organized walkouts and drawn negative media attention.
Because job review sites and social media are widely used today, severance packages have become especially important for companies to offer. Laid-off employees who feel they were underappreciated or undercompensated may post negative reviews and updates on Glassdoor, Facebook, and other social media platforms. Such opinions can hurt your employer brand, as they may be some of the first descriptions of your company seen by customers and job candidates who research your organization. This can have significant impacts on your bottom line. Harvard Business Review found that a bad reputation costs companies about $4,723 more per hire.
All of these reasons serve as strong incentives for companies to offer severance pay. Of course, one other big reason many companies choose to offer severance pay is due to a sincere desire to do the right thing for their employees. Most American workers need financial help in the event of a job loss. CareerArc’s Layoff Anxiety Study found that 47% of American workers are ill-prepared for a potential layoff. Providing a severance package to support these employees during this difficult time could make the difference between a relatively painless job change and a major financial hardship. As Entrepreneur points out, providing severance pay shows “you have some level of regard for [your departing employees] and will not leave them high and dry.”
How is severance pay determined
If your company chooses to provide severance pay to terminated employees, it’s a good idea to create a plan to decide how severance pay is determined. A clear plan will let you avoid having to enter into individual negotiations to determine each affected employee’s salary. In addition, a plan helps maintain fairness and consistency across your organization.
Here are the main factors to consider when deciding how severance pay is determined at your company.
Reason for termination
The primary time your organization should consider providing severance pay is in the case of a layoff or reduction in force. Usually, severance pay is given during a layoff notification meeting to employees who are laid off. If an employee leaves the company voluntarily, or if the employee is fired for cause, companies do not customarily offer severance pay.
In the case of executives and senior-level management, however, many companies still often extend severance pay even if the employee is being terminated for reasons other than a layoff. This is due to preexisting agreements the company may have with the employee, the general expectations of a severance package by employees at this level, and the increased potential for litigation.
Length of employee’s service
As a general rule, companies provide between one to four weeks of pay per year an employee has been with the company. This recognizes and rewards the loyalty and contribution of the employees who have been with an organization for a longer period of time.
Employee’s position in your organization
Severance pay is also often tied to an employee’s position in the hierarchy of the company. For example, entry-level employees might be given one week of pay per year worked, while senior-level employees might be offered a month of pay per year of service. Mid-level employees might expect two to three weeks, while CEOs and other C-suite employees may expect even more compensation.
The value of other benefits in your severance package
Forbes points out that severance pay is just one part of a bigger severance package, which can include extension of health and other benefits, retirement benefits, stock options, and outplacement services to help departing employees find new jobs. Thus, you might raise or lower the amount of severance pay given to exiting workers based on the value of the other items in your severance package.
For example, as part of a severance package, many companies offer to continue paying for a departing employee’s health benefits for several months to a year. This frees affected workers from worries about a lapse in their health coverage while they look for a new job. Instead of providing this benefit, your company could choose to simply give the affected employees additional severance pay, which they can use to either pay for COBRA health insurance or a different health insurance option, should they need it.
Commission, bonuses, and other expected compensation
Depending on how your company generally determines employee pay, severance pay for departing workers may also include unpaid commissions or bonuses. In addition, your company may have other existing policies, such as compensating employees for unused sick days or other paid time off, that should be taken into account when calculating severance pay.
Existing company policies
Some companies already have policies in place regarding severance packages. These policies may detail when severance pay is offered, how severance pay is calculated, and what other benefits are included in severance packages.
If your company has stated such policies in the employee handbook or individual employee contracts, you could be legally obligated to offer severance packages that follow those policies.
While a severance pay plan will help you standardize how severance pay is determined for the majority of your employees, you will likely run into situations where you’ll need to deviate from that plan. For example, if an employee has proprietary company knowledge that you want to protect, you might need to provide additional severance pay as an incentive for the employee to sign a non-disclosure agreement.
You’ll also likely need to negotiate severance pay for most executives on an individual basis, as the expectations and the extenuating circumstances for high-level employees tend to be unique to the individual.
Your organization’s needs
When deciding how severance pay is determined for your company, you’ll also need to carefully consider your organization’s financial resources. Of course, the severance pay your company offers must be in line with its ability to pay it.
There’s no cut-and-dried formula for determining your company’s severance pay, because calculations will always depend on the unique situation of your company and the affected employees. Still, following these general guidelines will assist you in figuring out the severance pay plan that works best for your organization.
Since figuring out how severance pay is determined is just one part of crafting a severance package, it’s important to also consider the other benefits you plan to include in your package as a whole. The goal of the severance package is not only to provide money for the terminated employee but also to support them in a more holistic manner in their transition out of your company. Since most laid off employees seek to quickly find new jobs, outplacement services are an important benefit to offer to help employees land new employment.
CareerArc Outplacement offers unlimited, on-demand, one-on-one career coaching to employees in career transition, along with expert resume reviews, video interview coaching, and a suite of other workshops, tools and services. Learn more about how CareerArc Outplacement can help you craft a severance package that best meets your workforce’s needs.