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Severance pay basics

Key takeaways

  • While severance pay is not required by law, many companies choose to provide it.
  • How much you receive typically depends on how long you have been with your employer.
  • Severance pay is taxable.
  • Accepting a severance package may come with strings attached, so it’s important to understand what you may be giving up before agreeing to anything.

Losing your job can be emotionally and financially draining. One bright spot may be receiving severance pay, which could help keep you afloat as you look for a new job.

Below is a closer look at what severance pay is, how it works, and what else might be in a severance package. Plus, get answers to common questions about severance pay so that you can make an informed decision if you’re ever offered severance.

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What is severance pay?

Severance pay is any compensation that your employer gives you when your employment there ends, beyond what you’re owed in remaining paychecks or unused time off that your company may pay out. It’s commonly offered to employees who are laid off through no fault of their own, but it is occasionally offered to other employees, including those who willingly resign.

A severance package can include a cash payment and other benefits. How much severance pay and additional perks you receive depends on your employer’s policies.

In general, the severance pay amount depends on how long you worked for the company. Often, companies choose a severance pay formula that pays out 1 to 2 weeks’ worth of wages for each year of a worker’s employment, but it can be a flat amount instead.

Do companies have to offer severance pay?

No. There is no US law that forces a company to offer severance pay to its employees. However, an employer may be required to pay severance in certain circumstances, such as when a worker’s employment contract calls for severance pay.

Why do employers offer severance pay?

Many employers offer severance pay because it can benefit the company in a few different ways. For one, offering severance pay to workers could help a company avoid negative press after layoffs. Also, severance agreements tend to stipulate that the employee cannot bring legal action against the employer if they accept severance pay. Because attorney fees and settlements can add up fast, offering severance may keep costs down overall when companies downsize or restructure. And then there are some businesses that offer severance pay simply because they want to do right by their former workers, regardless of the costs to the business.

What is typically included in a severance package?

While severance packages can vary substantially from company to company and from employment contract to employment contract, they commonly include:

  • Severance pay, as discussed above
  • Payout of unused paid time off (PTO), including vacation time and sick time
  • Continued health insurance coverage at the same rate, for a certain period of time
  • Continued dental, vision, and life insurance at the same rate, for a certain period of time
  • Continued company perks (such as employee discounts), for a certain period of time
  • Outplacement services, such as career counseling, training, and job placement assistance

In some cases, employers may allow laid-off workers to keep company equipment, such as laptops.

Your employee handbook may outline your company’s severance package policies, or you may find details in your employment contract or offer letter. If not, your company’s HR department may be able to help you understand severance policies. But it’s also possible for companies to offer severance on a case-by-case basis, and different employees may receive different packages—or none at all.

Can you negotiate severance pay?

Yes. You can typically negotiate severance pay at 2 key moments: during the hiring process and once you’re offered severance pay after a layoff.

Negotiating severance pay during the hiring process

Job offers typically include the benefits you’ll be entitled to as part of your employment, which may or may not include severance pay. If the offer doesn’t mention severance, you can request to add it. If it does include severance, but you aren’t happy with the package, you can try to negotiate better terms. Proceed with caution, though: Unless your industry is notorious for frequent layoffs, some hiring managers and recruiters might see talking about losing your job before you’ve started as a red flag—it could make them think you frequently get let go and question whether you’ll last long at their company.

Negotiating severance after termination

If you didn’t negotiate severance pay during the hiring process (or even if you did), you may also be able to if the time comes that you are let go. If you are offered a severance package, you don’t have to accept it immediately and can use the time your employer gives you to decide to negotiate. This is usually a few days to a few weeks, though the time frame can vary.

This could be risky. If you negotiate, your employer may decide to rescind severance pay altogether. Carefully consider whether it’s worth negotiating before you go for it.

Severance negotiation tips

Whether you’re asking for a severance package to be added to your offer letter or for a bigger payout after a layoff, offering something to your employer can help. For example, if you were not already required to, you might offer to sign a non-compete or non-disclosure agreement in exchange for a more generous package. Or if you’re being shown the exit, you could volunteer to train employees on the tasks they’ll be taking over from you. Another idea: Find out what the company’s competitors offer in severance through online research or asking contacts who have worked there. Then, share the data with your would-be or former manager and request that amount.

Is severance pay taxable?

Yes. According to the IRS severance pay is taxed in the year it was received. Your former employer would likely automatically withhold those taxes, and your severance pay would be included as part of the total income listed on the W-2 your employer sends for the year they paid your severance.

As for how much you're taxed on your severance pay, that depends on how your employer pays you. If your employer pays out your severance as a part of your normal wages, you can expect the same withholdings that you would normally see come out of your paycheck. If, on the other hand, your employer pays severance as what the IRS calls supplemental wages, it gets trickier. Your employer may apply a flat withholding rate of 22% or go for another option the IRS offers.

If your employer also compensates you for unused PTO (as in, they "cash out" your time off), that income would also be taxable.

If you receive more in severance or cashed-out PTO than you would have received in regular pay—say, because the company paid you a lump sum equal to more weeks of work than there are left in the year—that amount could push you into a higher marginal tax rate for the year. In that case, you might owe more in taxes than you would expect. Likewise, you might be ineligible for certain income-based tax credits or deductions that you previously were able to claim because of this windfall.

Can you collect severance pay and unemployment benefits at the same time?

It depends on the state. Some prohibit it. Some allow it but take the amount of your severance into consideration in calculating reduced unemployment benefits. Some allow double-dipping because they don't treat severance pay as income. In other states, you may not be eligible for unemployment benefits immediately if you receive severance, so if you can afford to wait, you could consider negotiating to receive severance pay after unemployment benefits dry up. Rules for unemployment benefits are all over the map, so check with your state's unemployment office for guidance.

If you aren't offered any severance, see if you're eligible to receive unemployment benefits in your state to help make up the loss in income.

Unemployment benefits or a severance package could be the lifeline that helps ease the transition to a new job. Still, because severance isn't guaranteed—or the severance you receive may be less than what you need—it's crucial to have adequate emergency savings to see you through a period of unemployment.

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