It can be stressful and frightening to lose your job. You have to find a new job, or maybe even change careers. What if no one is hiring? How are you going to make ends meet until you find a new job?
To ease the transition, some employers offer a severance package to employees who are laid off. The package might include compensation, continued benefits, or other perks, like outplacement services. When facing the possibility of being out of work with bills to be paid, a chunk of money from your employer on the way out the door probably sounds like a great deal.
Before you sign a severance agreement, though, make sure you understand the details. The money you receive as severance typically doesn't come for free. You may be asked to give up certain rights, like the right to sue your employer. You may be able to negotiate a better severance deal, especially if you have a potential legal claim against your employer (for unpaid wages or discrimination, for example).
Severance and Releases
You may be surprised to learn that no law requires employers to offer severance to all departing employees. However, a few states do require employers to pay a small amount of severance when they close a plant or conduct mass layoffs. And, employers must pay severance when they have agreed to do so. For example, if your employer promised you severance in an employment agreement or in an employee handbook, that might be an enforceable promise. Or, if your employer routinely grants severance to all employees when they leave, you might be able to argue that this practice has created an enforceable contract.
Otherwise, however, you are likely not legally entitled to severance. Some employers choose to provide severance, though, as an act of good will to show appreciation for your work and to ease your transition to a new job. Good intentions aside, however, one of the main reasons employers offer a severance package is to get the employee to leave as quickly and quietly as possible—that is, without filing a lawsuit or other legal claim against the company.
Sound harsh? Unfortunately, it's true. Practically every severance agreement asks the employee to give up (or "release") certain rights in exchange for the money and other benefits in the package. To an employer, the most important of these rights is the opportunity to sue for discrimination, retaliation, wrongful termination, or other legal disputes that arose out of your employment or termination.
For example, you may think that you're being laid off because of your age or gender, because you filed a claim for workers' compensation, or because you took leave under the Family and Medical Leave Act (FMLA). It's illegal to fire an employee for any of these reasons. These types of lawsuits can be very expensive for an employer—and can damage its reputation in the business community.
No matter how strong your claims are, you won't be able to sue your employer if you sign a valid release of your right to do so. If you have any legitimate reason to believe that your layoff is illegal, don't sign the severance agreement until you've talked to an attorney.
Severance agreements typically include trade secret protections. For example, you may have to agree not to use or divulge any of your employer's trade secrets or other confidential information, like customer lists or recipes. Also, be aware that the severance agreement may include a noncompete clause, limiting your ability to work for other employers. Noncompete provisions typically prohibit you from working for a business or company that competes directly with your old employer. They may also stop you from opening your own competing business. Consider a noncompete clause carefully before agreeing to it.
What’s in Your Severance Package?
Most severance packages offer a number of benefits. And, they’re not always set in stone or offered as a "take it or leave" proposition. Sometimes you can negotiate a better deal, and sometimes you have to make important choices.
Severance pay. Most severance packages include extra compensation. The amount can vary greatly, depending on your employer (and what rights you’re being asked to give up). Some employers offer a standard one or two weeks of salary. Other employers use a formula based on your current salary and the number of years you've worked for the employer (for example, one week of salary for every year of service).
When it comes to severance pay, you may be able to negotiate more than what's being offered. Maybe you were an exemplary employee with long service, or you were set to receive a pay raise or promotion before the layoff. Facts like these may help you increase your severance pay by a week or two, maybe more. If you have potential legal claims against the company, you might have even more bargaining power; an employment attorney can help you figure this out, including how much you should demand to give up those claims.
Accrued time off. Some employers offer to pay you for accrued vacation, holidays, and sick time that you haven't used before the layoff. Some may offer to pay a portion or percentage of your accrued time off, while others may offer nothing at all.
Before you agree to accept what your employer is offering, check your state law. Some states require employers to pay out all accrued, unused vacation time or paid time off (PTO). If your state has such a law, or you have an employment agreement that already obligates your employer to pay you for this time, you should not have to give up any rights to get it.
Insurance. You don't need to be told that insurance is expensive. Generally, your employer-paid insurance benefits end when you're laid off, unless you continue them at your own expense. Before you sign the severance agreement, consider the types of insurance you may need:
- Health insurance coverage might be offered as part of your severance package. Because it’s a costly benefit, however, not all employers offer it. And, even if it is offered, don’t expect to get more than a couple of months. Also, under the Consolidated Omnibus Budget Reconciliation Act (COBRA), if your employer has at least 20 employees, you can continue you current coverage for up to 18 months. However, you will have to pay all of the insurance costs and premiums. Before you sign up, check out the available health plans under the Affordable Care Act, at www.healthcare.gov, to see if you can get a better deal.
- Disability insurance, if you had it, will most likely be discontinued at the time of your layoff. You may be able to negotiate continued coverage, or you can check to see if your state offers short-term or long-term disability benefits.
- Life insurance will also likely end when you're laid off. You'll either have to negotiate continued coverage through your employer or buy your own policy.
Unemployment benefits. In some states, you may agree to waive or forfeit your right to receive unemployment benefits in exchange for severance—or the state’s unemployment laws may disqualify you from receiving benefits for as long as your severance lasts. In other states, you have the right to benefits regardless of any severance you receive or any contract you sign to the contrary. You should check your state's unemployment agency to see if you're eligible for benefits if you accept a severance package.
Payment method. You may get to choose between being paid all at once in a lump sum or periodically, just like receiving weekly or biweekly paychecks (sometimes called salary continuation). This decision is important because:
- A lump sum payment may be taxed as a "bonus" or "supplemental wages," which has a higher tax rate than regular income. In contrast, salary continuation payments will usually be taxed as regular income. An accountant can help you figure out the financial impact of each option.
- If you need money immediately, a lump-sum payment might make more sense. It may take up to two weeks before you see any severance money if you choose salary continuation.
- In some states, salary continuation payments are treated as income for purposes of unemployment compensation benefits. So, if your payments are equal to or more than your pre-layoff salary or wages, you may be ineligible for benefits while you are receiving severance.
Time to decide. The severance package will tell you how long you have to consider the offer. Sometimes you're given only a few days; in other cases, you may get a week or two. If you're at least 40 years old, the federal Older Workers Benefit Protection Act requires your employer to give you at least 21 days to think about the offer and seven days to change your mind after you sign.
The key here is to make a decision before the offer expires. If you want to negotiate with your employer, talk to a lawyer right away, so you’ll have time for offers and counteroffers.
Questions for Your Attorney
- Can my employer require me to accept or reject a severance agreement on the spot?
- A coworker was offered more severance pay than I was, even though we've been with the company the same amount of time. Is that legal?
- Can I get around paying taxes on my severance pay by having my employer deposit the money into my 401(k)?
- How will my severance package affect my eligibility for unemployment benefits?