Severance pay is offered as a benefit to employees in the event that they should lose their job through no fault of their own. It protects the employer from the threat of legal action being filed by an ex-employee as well as helps the ex-employee through what is likely to be a difficult financial period.

How it Works

Severance packages are usually spelled out in the terms of the contract or agreement that an employer has with an employee regarding the compensation package offered. Severance packages are negotiable. However, many large companies avoid these negotiations and do not offer any compromises. Severance benefits are typically paid in the form of a periodic check or in one lump sum. If severance benefits are distributed as one lump sum, there is likely to be a higher tax placed on the pay since it is treated no differently then a large bonus. This loss in pay can be made up by proper filing of tax returns, but will delay the receipt of the full payment during a period of time in which money is likely to be tight.

General Tips

Financial experts advise that individuals who receive severance pay contact the business’s financial department in order to advise the department that they would no longer like portions of their pay to be directed towards a 401(k) plan or other fund of the same sort. This will allow the full amount of pay due the ex-employee to be obtained for use as designated by that individual. Some severance packages even include classes that help a newly released employee regain their confidence, work on their resumes and gain access to job listings. These programs are refereed to as outplacement services.

Insurance Effects

Generally, the employer will stop providing health coverage at the time of an individual’s termination. However, the Consolidated Omnibus Budget Reconciliation Act (COBRA) allows ex-employees to retain the same amount of health coverage provided that the ex-employee takes up small, group based payments plus a small administration fee. Some severance packages offer to pay for the first few months of COBRA assistance while others leave the responsibility to the ex-employee. Life insurance is not covered under COBRA and may or may not be offered as a benefit of most severance packages.

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