While companies are not required by federal law to provide severance pay to terminated employees, many voluntarily choose to do so. This brings up a crucial question for HR experts: how is this type of pay calculated?
How Is Severance Pay Calculated?
If your company chooses to provide severance pay to terminated employees, it’s a good idea to create a plan to decide how it is determined. A clear plan will help you avoid having to enter into individual negotiations to determine each affected employee’s salary. In addition, a plan helps maintain fairness and consistency across your organization.
Here are the main factors to consider when deciding how severance pay is determined at your company.
Reason for termination
The primary time your organization should consider providing severance pay is in the case of a layoff or reduction in force. Usually, this benefit is given during a layoff notification meeting to employees who are laid off. If an employee leaves the company voluntarily, or if the employee is fired for cause, companies do not customarily offer severance pay.
In the case of executives and senior-level management, however, many companies still often extend severance packages even if the employee is being terminated for reasons other than a layoff. This is due to pre-existing agreements the company may have with the employee, the general expectations of a severance package by employees at this level, and the increased potential for litigation.
Employee’s position in your organization
The severance pay formula is also often tied to an employee’s position in the hierarchy of the company. For example, entry-level employees might be given one week of pay per year worked, while senior-level employees might be offered a month of pay for every year of service. Mid-level employees might expect two to three weeks, while CEOs and other C-suite employees may expect even more compensation.
The value of other benefits in your severance package
Forbes points out that severance pay is just one part of a bigger severance package, which can include extension of health and other benefits, retirement benefits, stock options, and outplacement services to help departing employees find new jobs. Thus, you might raise or lower the amount of pay given to exiting workers based on the value of the other items in your severance package.
For example, many companies offer to continue paying for a departing employee’s health benefits for several months to a year. This frees affected workers from worries about a lapse in their health coverage while they look for a new job. Instead of providing this benefit, your company could choose to simply give the affected employees additional pay, which they can use to pay for COBRA health insurance or a different health insurance option, should they need it.
Commission, bonuses, and other expected compensation
Depending on how your company generally determines employee pay, severance pay for departing workers may also include unpaid commissions or bonuses. In addition, if your company has other existing policies, such as compensating employees for unused sick days or other paid time off, that should be taken into account.
Existing company policies
Some companies already have policies in place regarding severance packages. These policies may detail how severance pay is calculated, when it is offered, and what other benefits are included in severance packages.
If your company has stated such policies in the employee handbook or individual employee contracts, you could be legally obligated to offer severance packages that follow those policies.
While a plan will help you standardize how severance pay is determined for the majority of your employees, you will likely run into situations where you’ll need to deviate from that plan. For example, if an employee has proprietary company knowledge that you want to protect, you might need to provide additional severance pay as an incentive for the employee to sign a non-disclosure agreement.
You’ll also likely need to negotiate this benefit for most executives on an individual basis, as the expectations and the extenuating circumstances for high-level employees tend to be unique to the individual.
Your organization’s needs
When deciding how this type of pay is determined for your company, you’ll also need to carefully consider your organization’s financial resources. Of course, the amount your company offers must be in line with its ability to pay it.
How to Calculate Severance Pay
Looking for a severance pay calculator? In some instances, you may be able to calculate severance pay yourself for your employees. The most common way to work out severance is to base it on an employee’s salary and the number of years they’ve worked for your organization. Most organizations choose to give around four weeks’ pay for each year the person has been employed (so someone who has worked there for three years would get 12 weeks’ pay, for example).
Below, you can find the severance pay formula to use:
[Employee’s weekly salary] x [Number of weeks](Number of years) = Total severance allowance
Therefore, if an employee has been part of your organization for five years on a weekly salary of $300 and you’d like to give them four weeks’ pay for every year, the severance pay formula would be:
$300 x 4(5) = $6,000
Calculating severance this way will reward the employees for their loyalty and tenure.
Figuring out how severance pay is determined is just one part of crafting a severance package. It’s also important to consider the other benefits you plan to include in your package as a whole. The goal is not only to provide money for the terminated employee but also to support them in a more holistic manner in their transition out of your company. Since most laid off employees seek to quickly find new jobs, outplacement services are an important benefit to offer to help employees land new employment.
What Are the Benefits of Offering a Severance Package?
Providing departing employees with a financial cushion of course helps smooth these workers’ transitions to new jobs, but the practice benefits the company too. Severance pay helps organizations maintain more positive relationships with departing employees, thereby protecting the employer brand and forestalling litigation. If a company does not provide this benefit, other costs often go up due to a higher cost-per-hire, an increased number of wrongful termination claims, and a shrinking customer base. In some cases, employees who haven’t been provided with severance pay have organized walkouts and drawn negative media attention.
Because job review sites and social media are widely used today, severance packages have become especially important for companies to offer. Laid-off employees who feel they were underappreciated or undercompensated may post negative reviews and updates on Glassdoor, Facebook, and other social media platforms. Such opinions can hurt your employer brand, as they may be some of the first descriptions of your company seen by customers and job candidates who research your organization. This can have significant impacts on your bottom line. Harvard Business Review found that a bad reputation requires companies to fork out higher salaries, costing them around $4,723 more per hire.
All of these reasons serve as strong incentives for companies to offer severance packages. Of course, one other big reason many companies choose to offer them is due to a sincere desire to do the right thing for their employees. Most American workers need financial help in the event of a job loss. INTOO’s Layoff Anxiety Study found that 47% of American workers are ill-prepared for a potential layoff. Providing a severance package to support these employees during this difficult time could make the difference between a relatively painless job change and a major financial hardship. As Entrepreneur points out, providing severance pay shows “you have some level of regard for [your departing employees] and will not leave them high and dry.”
INTOO’s outplacement solution offers unlimited, on-demand, one-on-one career coaching to employees in career transition, along with expert resume reviews, video interview coaching, and a suite of other workshops, tools and services. Learn more about how INTOO’s outplacement solution can help you craft a severance package that best meets your workforce’s needs.