What Is Severance Pay?: A Guide for 2021
The last year’s been brutal for tech startup employees. Nearly 90,000 employees at 618 tech startups have lost their jobs since March 2020, according to stats compiled by Layoffs.fyi.
The site also logs severance packages offered by tech companies like Eventbrite, Stitch Fix and Yelp. Severance pay and packages range from two weeks of pay to four months of pay; one firm offered 13 weeks of base pay with an extra week per year of service. Extension of healthcare coverage also was part of many severance packages.
That’s what usually happens when you are fired or laid off from a job. Your ex-employer will soften the blow with a severance package that includes pay, often a continuance of your healthcare coverage, and perhaps other benefits, for instance paying for services to help you find a new job.
What is severance Pay?
While severance can help carry you through the financial uncertainty of unemployment, it’s not free money. We asked two employment attorneys, one who represents employees and the other, employers, to walk us through severance-agreement basics.
Why do companies offer severance pay?
“To help achieve an amicable separation, provide some financial support for an employee whose position has been terminated, and to receive a separation and general release agreement to help ensure that the departing employee will not bring legal claims against the company,” said Sonya Rosenberg, an employment attorney and partner at Neal, Gerber & Eisenberg in Chicago. Rosenberg represents employers during severance negotiations.
What is severance pay?
“Severance pay is money that is provided to you by your former employer in exchange for a release of claims,” said Deane Brown, shareholder at Hughes Socol Piers Resnick & Dym Ltd. in Chicago, who represents employees in these matters. “It’s money that can help tide you over until you find another position,” she said.
“Severance agreement” is a more accurate descriptor than “severance pay,” Brown said. First, these instruments are indeed agreements, often negotiated, between you and your ex-employer. Second, they usually involve much more than money. Health insurance, non-compete, confidentiality, non-disclosures and other provisions, and even keeping your company laptop or cell phone (wiped of confidential company info) can be part of an agreement.
What’s a release of claims?
“No employer gives you money out of the goodness of their heart,” said Brown. A severance agreement is an exchange of money for promises that the soon-to-be ex-employee will not make a claim against the company. Women, people of color, people 40 and older, people with a mental or physical disability or belonging to another demographic group protected by federal or state law might want to file a claim against their former employer for unfair treatment or discrimination. Accepting severance pay and signing an agreement signals that the employee will not take action against the company.
That said, terminated employees who’ve accepted severance cannot be stopped from reporting discrimination to the federal Equal Employment Opportunity Commission or their state’s department of human rights, Brown said. Employees will, however, be required to waive any monetary settlement from discrimination claims as part of a severance agreement.
Are severance agreements just about money?
The agreements can also include confidentiality provisions, meaning you won’t disclose the amount of your severance pay or terms of the agreement. Terminated employees might be asked to sign a non-disparagement agreement, meaning they won’t badmouth the company or its employees after they leave. Non-disclosure agreements, or NDAs, might be part of the package; those agreements state that the fired employee will not divulge confidential information and trade secrets. (Brown pointed out that most companies require employees to sign NDAs before their employment begins.)
High-level managers might also be asked to sign non-compete and non-solicit agreements. Non-competes mean they won’t join a competitor or launch a competing startup within a certain time frame after leaving the company. Non-solicits mean they won’t go after their old company’s clients or employees. Brown said that employment non-solicits are increasingly being called non-hires: “In the hiring process, it’s hard to tell who recruited whom,” she said, so the agreement means you won’t hire your old company’s workers, no matter who makes the initial contact.
Severance agreements can also include health insurance. In fact, the recently enacted federal American Rescue Plan mandates that companies pay full COBRA health insurance premiums for eligible employees from April 1 through September 30, 2021. Plus, they can also have an agreement not to forfeit unvested stock options or other stock benefits tied to your old company; what you get to keep depends on the terms of the equity plan that governs stock options.
On rare occasions, and usually with top-level managers and C-suite employees, employers might agree to allow former employees to retain their unvested stock options and allow the options to vest over time, as if they were still working at the company.
Does everyone get severance pay?
No. Employees who quit a job generally do not receive severance. Employees fired for cause — for example, they’ve stolen from the company or exhibited criminal behavior or egregious misconduct — generally do not receive severance.
Fired or laid off due to a workforce reduction? You generally will get some form of severance, again in exchange for a release of claims. For those gray areas — you’re underperforming or unhappy at work and your boss knows it, and the two of you agree it’s time for you to start looking — severance agreements might or might not enter the picture. A negotiated agreement could call for money in exchange for transitioning your duties to your successor, plus giving you time to look for another job. “It’s easier to find a job when you have a job,” Brown pointed out.
If you are in that gray area and feel like you’re getting pushed out the door, stay put. “I tell my clients not to quit,” Brown said. “If you quit, you don’t get severance and you don’t get unemployment benefits.”
How is severance pay calculated?
“There’s no bright-line rule on that,” said Rosenberg. She noted that companies sometimes are contractually bound to pay a certain amount of severance, if certain conditions are made, through an employment agreement signed with an employee (usually a higher-level executive). Absent that kind of arrangement, “employers are best advised to assess what's fair and consistent with market practice, and to think about the precedent paying a certain amount will set,” Rosenberg said. Typically, it works out to one or two weeks of severance for each year of service.
Do I pay taxes on severance pay?
Yes. Severance is considered wages and you’ll pay applicable state and federal income taxes on it.
How will I get the severance pay?
One of two ways — either as a lump sum or in payments, going into your bank account with taxes and insurance deducted as if you still worked for the company. Brown prefers the lump-sum approach. “I always try to get my clients a lump sum payment, because I don’t want the employer to turn off the spigot if they believe my client is violating a confidentiality or non-disparagement provision or the restrictive covenants contained in the agreement,” Brown said. “If they do believe there’s been a breach of the severance agreement, they can stop paying.
Can I file for unemployment benefits if I get severance pay?
Yes, you can file, but the question is whether you’re eligible, Rosenberg said.
“If your employment has been terminated and not for serious misconduct reasons, you typically would be eligible for unemployment,” she said. Severance pay might also offset the unemployment benefits, she added.
Brown said that the answer to this question varies by state, and suggested checking with your state’s workforce development office or employment security office for details.
How should I spend severance pay?
“Pay your rent and other expenses that you’re going to incur, because you don’t know how long it’s going to take you to find another job,” Brown said.
When is it okay to say no to a severance agreement?
If you don’t want to be bound by the terms of the agreement — say you do want to start a competing company or plan to make a discrimination claim against the company and seek damages — then don’t sign the agreement and don’t accept the money.
When clients tell Brown that they feel they’ve been wronged or discriminated against, she often writes a strongly-worded letter to the company outlining the potential legal claims to negotiate a better severance agreement for her clients.
Some severance agreements stop paying when the former employee finds a new job. “It’s very rare that I see that, but I have seen it, and urge my clients not to sign those, because I really don’t think your former employer should benefit from your ability to find a new job,” she said. “My view is you’re being paid severance to release any and all claims against your former employer,” not to remain unemployed.
Should an attorney review an agreement before I sign?
“Absolutely, one hundred percent,” Brown said. “You want to know exactly what you’re giving up, what you’re getting, and how the agreement will impact your future employment.” Brown offers free half-hour consultations with people who think they have a claim and want to leverage it for a better severance agreement. If they don’t, “I’d say just take the severance and move on,” she said.