Severance Pay Laws: Does It Make Sense to Offer Severance Pay?

Small businesses and large companies must face the day they must let go of employees. Sometimes, it's for good cause — the departing employee wasn't a good fit or can't move with the company. Sometimes, it's economics, and layoffs are necessary for your business's survival. In these cases, business owners may want to make the transition easier for their former employees.

Surprisingly, there are no state or federal severance pay laws. Employers can hand workers their pink slips and final paychecks and show them to the door. There are no legal requirements to offer severance packages. Most employers offer their workers severance pay when they can.

Sometimes, small business owners must give their employees some termination payments. Sometimes, severance pay is a way to protect yourself from legal action. This article reviews both circumstances and what business owners should remember when creating a severance policy.

When You Must Give Severance Pay

In 1988, responding to a wave of layoffs at auto plants and other industrial facilities, Congress passed the Worker Adjustment and Retraining Notification Act (WARN). This law applies to any business with over 100 employees and requires companies to give workers at least 60 days' notice of an impending shutdown.

As of March 2024, 18 states have similar laws called "mini-WARN Acts." State laws apply to businesses with fewer employees, including small businesses. Most of these laws do not require severance pay, although employers must give workers their final paychecks at the time of the layoff.

An employer must only offer a severance package when the employment contract or company policy states that terminated employees will get one. Situations where you may have to provide a severance payment include:

• An employment contract or collective bargaining agreement that mentions a severance package
• A statement in your employee handbook or company policy that mentions severance benefits
• A company history of giving severance packages to similarly situated employees
• A verbal promise to an employee that they would get severance pay

When You Should Give Severance Pay

Although you do not have to provide a severance package, human resources professionals suggest it may be a good idea. Large corporations often offer severance pay to executives and employees who have worked for the company for a significant amount of time.

Companies may also offer voluntary "retirement bonuses" that are severance packages when the company is downsizing or merging with another company. Rather than lay off employees by seniority, companies offer older workers extra money and perks for leaving early. These early retirement bonuses are a form of severance pay.

The Fair Labor Standards Act (FLSA) and other federal laws do not directly mention severance pay. They say all "similarly situated" employees must get the same compensation. There is no legal definition of "similarly situated." For severance pay purposes, all employees of approximately equivalent status are equal.

You may consider giving a severance package to high-risk employees. These are workers you must fire but who present a liability hazard. Perhaps the worker is a protected class member and does not accept the grounds for their termination. Maybe the person is volatile and has made physical or legal threats against the company.

If you have a situation where you want a "high-risk" employee to have a severance package, get legal advice from an employment law attorney before writing and offering a severance agreement.

Things To Include in a Severance Package

When an employee leaves your company, there are some things you must give them. Employees must get their final paycheck, retirement benefits, and the right to continue their health insurance. A severance package should be something more. Unless your employment agreement specified particular items, consider some of the following:

• Bonus pay: Extra pay can be a benefit if employees are laid off or asked to retire early. The usual figure is a week's pay for every year of service. They usually get the extra pay as a lump sum. The employee generally also gets paid time off or vacation time.
• Health insurance: The Consolidated Omnibus Budget Reconciliation Act (COBRA) allows terminated employees to continue their group health insurance coverage, even when fired for cause. Severance bonuses sometimes offer to pay the COBRA premiums for a short period. Confirm this with your insurance carrier since COBRA payments can be over 100% of the employer's cost.
• Unemployment benefits: The purpose of the WARN Act and state mini-WARN laws is to give employees time to file for unemployment compensation. Benefits can take several weeks to kick in, and employers can speed the process by quickly responding when they get the worker's claim.

Things To Consider Including in Your Severance Package

You may not want to put everything in all severance packages. The contents of your package depend on the reason for the employee's departure. Employees who get laid off or take early retirement may get some of these extra benefits. So-called "high-risk" employees may not qualify for these benefits.

• Outgoing employment services: If your company has a human resources department, outplacement services can help workers find new jobs. Large corporations with high turnover often have these services to help workers during mass layoffs. Small business owners could consider referrals or recommendations.
• Letters of recommendation: Approach these cautiously. Letters of recommendation can be powerful incentives for departing workers and protect you from possible legal action. They can open you to other forms of liability if you're not careful. This is another area in which to seek legal advice.

Get Legal Help With Your Severance Pay

Terminating employees is never enjoyable. A severance package can ease the transition. Have an employment law attorney review your severance agreement to ensure it contains the appropriate items.