What Is Severance?

If you are laid off from work, you may be eligible for a severance package. Not all employers offer this type of pay — but for employers who do, it can be hugely helpful during the transition period for laid-off employees.

But what is severance pay, exactly, and how does it work? This guide will explore the topic in-depth. 

What is severance pay?

Severance pay is a type of compensation that may be offered to employees who are laid off. It is a temporary program that provides pay during the transition period after leaving a job. 

Severance is most often offered to employees who are laid off through no fault of their own — as a result of budget cuts, for instance. 

It is very rarely offered to employees who are fired for misconduct or poor performance. Some employers may choose to offer it to employees who voluntarily quit, but this is also less common. 

The details of employer severance pay will be laid out in a severance agreement. This will dictate the amount of pay, the length of time it’ll be paid, and other key components. Each company will have its own details when it comes to severance pay. 

What is a severance package?

A severance package is a package of pay and benefits offered for employees who are laid off. 

It typically includes pay for a set period, usually a portion of the original salary, as well as certain benefits. 

The details vary by employer. Continuation of healthcare coverage is common, and some employers may offer other benefits, such as assistance in finding a new job. 

Are companies legally obligated to offer severance pay?

In general, no. Severance isn’t legally required federally, and only a handful of states have rules for it, which can vary by state; it’s worthwhile to read up on labor laws in your area. In general, severance pay is an optional perk that employers can choose to voluntarily offer their employees. 

How much is severance pay?

A general rule of thumb is that employers may offer one to two weeks of severance pay for every year the employee worked at the company. 

For example, if an employee worked at the company for five years, they might be offered 5 to 10 weeks' worth of pay as severance. If they earned $52,000 per year ($1,000 per week), that severance package could be worth $5,000 to $10,000. 

Severance pay is often paid as a lump sum, meaning all at once. However, some employers may choose to continue issuing standard paychecks for an agreed-upon length of time. 

However, severance pay packages vary in detail and size. Remember, severance is an optional program with no laws dictating its generosity. The specifics are typically left up to each employer. 

Is severance taxable?

Yes, severance pay is considered taxable income for the year in which it was received. It’ll be included on your W2, the main tax form you receive from your employer each year. 

Finally, consider that lump-sum severance payments could potentially affect your tax situation. If you are laid off in December, for example, your lump-sum severance package could increase your taxable income for the year (and therefore, your tax liability). Speak to a tax advisor for details. 

Example of a severance package 

Company XYZ offers employees one week of severance pay for every year they’ve worked at the company. In addition, they offer an extension of health insurance for three months after leaving the job (regardless of time worked at the company). 

A round of layoffs is announced. 

• Employee A has worked at the company for two years and earns $800/week. They’ll receive $1,600 in severance pay (two weeks)

• Employee B has worked at the company for eight years and earns $1,000/week. They’ll receive $8,000 in severance pay (eight weeks)

• Employee C has worked at the company for 13 years and earns $1,100/week. They’ll receive $14,300 in severance pay (13 weeks). 

All three employees will receive three months of health insurance coverage. 

As you can see, severance pay packages are typically structured to reward longer-term employees with more benefits. 

What to do if you are laid off

If you are laid off, or even if there are rumored layoffs coming at your company, it pays to be prepared. Here’s what to consider. 

Negotiate severance

Severance packages can potentially be negotiated. For example, if your employer offers two weeks of pay for every year you’ve been with the company, you might negotiate for three weeks of severance. 

Make a financial plan

Approximately 64% of Americans live paycheck to paycheck. That means for two-thirds of the country, a job loss could lead to significant financial problems almost immediately. 

It’s important to have a financial plan for how you’ll recover from a job loss. Consider the following:

• Set aside your severance pay into a savings account to pay for routine expenses over the next few months

• Start looking for a new job immediately

• Cut back on optional expenses temporarily (dining out, entertainment, etc.)

• Have a financial conversation with your partner, if applicable

Apply for unemployment insurance

Unemployment insurance is a state-level program that helps provide temporary pay for workers who are laid off. Unemployment is taxpayer-funded (a percentage of your paycheck goes to these programs), and run by state governments.  

Check with your state’s program for details on how to apply. You can see a full overview of each state’s offerings here. 

Extend health insurance through COBRA

Health insurance coverage is typically tied to the employer, so if you lose your job, you will likely lose your health insurance. Fortunately, a federal program called COBRA exists to help bridge the gap. 

COBRA essentially helps people stay on their existing employer health plans temporarily after they quit or have been laid off. Workers typically need to pay the entire cost of the plan, but it allows them to keep health coverage with no interruptions. 

Strengthen your finances

One of the best things you can do to strengthen your financial position is to pay off high-interest debt. And for that, Tally† may be able to help. Tally is a personal finance app that may help qualifying applicants consolidate credit card balances to a lower interest rate. 

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.