# Severance Pay Explained: Benefits, Taxes, and What You Need to Know

## What Is Severance Pay?

Severance pay provides financial support to employees when their positions are terminated due to layoffs or job elimination. This compensation, sometimes extending beyond regular pay, often includes benefits like health insurance or outplacement services to ease job transitions. Employers are not legally required to offer it, but many do to mitigate the impact of termination. Understanding severance packages, outlined in handbooks or contracts, helps employees manage their finances during career transitions and assess the impact on unemployment benefits.  

### Key Takeaways

*   Severance pay is a type of compensation employers provide to employees who are laid off or whose jobs are eliminated, often including benefits beyond regular pay.  
    
*   The terms and amounts of severance packages vary and are typically influenced by factors such as the length of employment and company policies.  
    
*   Although not legally required, many companies offer severance pay to reduce the impact of job loss and to prevent potential legal issues.  
    
*   Severance pay is generally taxed as regular income, which can affect the financial planning of employees who receive it.  
    
*   Receiving severance pay might impact an employee's eligibility for unemployment benefits, depending on how the severance is structured and state laws.

![Severance Pay](https://www.investopedia.com/thmb/9nqsHJoTJhRS6vmQstIU3swBYbc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/severancepay.asp-final-32f0096580d6489aa78ad87a2dc84e6a.png)

*— Investopedia / Theresa Chiechi*

## Key Elements Determining Severance Pay Amounts

Severance pay is offered to employees in certain circumstances after their employment ends. The amount an employee receives often depends on how long they were with the employer. Most employers have policies in their employee handbooks that outline how they handle severance pay.

Packages offered by employers usually come in a lump sum and are taxable. They generally include an employee's regular pay along with some or all of the following:

*   Extra pay based on months or years of employment
*   Compensation for unused, accrued vacation time, sick days, and/or holiday pay
*   Medical and dental benefits, and life insurance
*   Retirement accounts and stock options

## Understanding Severance Pay's Effect on Unemployment Benefits

Severance pay can affect [unemployment compensation](https://www.investopedia.com/terms/u/unemployment-compensation.asp) in two ways. If severance is paid in a lump sum, the employee can apply for unemployment insurance immediately.

Sometimes, companies spread severance pay over several months. In this situation, the employee remains [on the payroll](https://www.investopedia.com/terms/g/gardening-leave.asp) even if they are not working. Similarly, if an employee has unused vacation time, they are on the payroll as they use it.

> **Important**
>
> The laws concerning unemployment and severance pay vary by state, so it's important to check with your local employment office about when to apply for unemployment benefits.

In some cases, severance pay impacts unemployment compensation due to contracts signed when accepting severance. In exchange for offering severance packages, some companies make their employees sign statements saying they voluntarily resigned from their posts.

These agreements stop employees from claiming unemployment insurance, meant for involuntary dismissals. It's wise to read documents carefully before signing; legal advice might help improve the severance offer

## An Example of Calculating Severance Pay

Company A is a large technology company based on the East Coast that is seeking to expand its footprint on the West Coast. In its efforts to expand, it decides to [purchase](https://www.investopedia.com/terms/a/acquisition.asp) Small Company B based in California which has a footing in the same business.

Company A wants to keep the bulk of the employees at Small Company B as they have experience in the local market; however, one division at Company B is similar in operations to an existing division at Company A, which is larger and has more experience. Company A finds the division at Small Company B redundant and decides to replace it with members from its existing team.

Therefore, the 10-person division at Small Company B is informed they will be laid off. All 10 employees will be offered severance pay, which will be equal to one month's salary for every year that they have worked there. So if an individual has worked at the company for five years, they will receive five months' severance pay.

## Why Offer Severance Pay?

Businesses are not required to pay severance, although most offer packages on a case-by-case basis and as dictated by employment contracts. When businesses fail to offer severance packages, it can upset staff and create negative public relations. The main goals are to soften the impact of an abrupt termination as well as to avoid any future lawsuits, as an employee has to sign a legal release in exchange for the severance.

## Do Businesses Have to Offer Severance Pay?

According to the U.S. Department of Labor, no law requires employers to provide severance pay; however, if an employee's contract stipulates that they receive 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 uphold that agreement.

Regardless of whether a company offers severance pay, the [Fair Labor Standards Act](https://www.investopedia.com/terms/f/fair-labor-standards-act-flsa.asp) (FLSA) mandates an employer must pay terminated employees through their last day of work, and the employer must also pay any accrued vacation time to employees.

## What Is Severance Pay Taxed at?

Severance pay is taxed at the same tax bracket as when you were fully employed and earning the same salary. This is the case if the severance payment is equal to what your salary was. If it is less, then you will be taxed at the appropriate tax bracket.

## Final Thoughts on Severance Pay and Its Implications

Severance pay provides a crucial financial cushion for employees laid off due to downsizing, redundancy, or other organizational changes. Although not legally required, many employers offer severance packages to ease the transition for employees and minimize potential legal conflicts. The amount and form of severance can vary, often influenced by an employee's tenure and the company's policies as outlined in handbooks or contracts. Severance payments are taxable and can impact eligibility for unemployment benefits based on the payment structure and state laws. It's vital for employees to carefully review any agreements and consider the tax implications when accepting severance pay.

> **Article Sources**
>
> 1.  New York State Department of Labor. "[Dismissal/Severance Pay and Pensions Frequently Asked Questions](https://dol.ny.gov/dismissalseverance-pay-and-pensions-frequently-asked-questions)."
>     
> 2.  U.S. Department of Labor. "[Severance Pay](https://www.dol.gov/general/topic/wages/severancepay)."
>     
> 3.  U.S. Department of Labor. "[Wages and the Fair Labor Standards Act](https://www.dol.gov/agencies/whd/flsa)."