A Guide to Severance Pay: With Definition and How It Works

By Indeed Editorial Team

Published 27 April 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Severance payment supplements an employee during their separation from a company as they search for new employment. When organisations offer severance packages, they may include their own terms and conditions. It's helpful to understand severance payment and its components to prepare yourself for negotiating benefits in case of any unexpected company layoffs. In this article, we explain what severance pay is, describe how it works, explain how companies determine what payment to offer and share tips to negotiate your severance package.

What is severance pay?

Severance pay is a payment and benefits package an employer pays to an employee on termination of employment. The conditions for receiving a severance payment often involve an involuntary employee layoff for many reasons. For instance, if a company acquires another company, some employees may share the same responsibilities as the two firms merge. As a result, the parent organisation may let go of team members to eliminate extraneous roles. Another example is when a company decides to switch to new automated technology, resulting in a certain group of employees at risk of losing their job.

Irrespective of the reasons, if an employee is eligible for a severance payment, the human resources manager may discuss the details during a one-on-one meeting. They may offer a severance package either as a result of the employment contract or a goodwill gesture from the employer as the employee transitions into unemployment and back onto the job market. Besides their remaining standard payment, severance packages may also include the following items:

  • any additional payment based on months of service such as allowances, commissions, overtime, reimbursed expenses

  • stock options

  • payment for any unused annual leave or sick leave

  • payment for any unpaid paternity or maternity leave

  • payment in lieu of notice if the employer doesn't require the employee to work during a notice period before termination.

  • assistance in searching for new work such as access to recruitment agencies or help in creating a CV

Related: How to Write a Termination of Employment Letter

How does severance payment work?

When an employee receives their layoff notice, the employer may offer them a severance package. While the severance payment process varies by company, the typical process may be as follows:

  1. The employer may notify the employee of a forthcoming layoff.

  2. The employer sets up a meeting with the employee to discuss further steps.

  3. The employer offers a severance package, often contingent upon signing a severance agreement.

  4. The employee may or may not negotiate for a higher severance package, depending on their years of service to the company.

  5. Upon signing the severance agreement, the employee may receive their severance package as a one-time settlement or multiple payments over the course of a specific number of months. The severance packages may also include benefits like a continuation of health insurance and other forms of payment.

  6. The employer notifies certain government entities such as the Mandatory Provident Fund (MPF) System, Inland Revenue Department (IRD) and the Immigration department, if the employee holds an employment visa, of the intended termination of employment.

Related: How to Deal with Job Loss

Why do companies offer severance payments?

The typical circumstances that require employers to offer severance packages are layoffs, job elimination, organisation restructure, retirement and mutual agreements to part ways. Employees can qualify for severance pay if they were part of the organisation under a continuous contract for not less than 24 months. Generally, companies don't offer severance payments to employees terminated for poor performance. Here are a few reasons a company may choose to provide a severance package to an employee:

  • Ensure that the individual doesn't sue the company for unpaid wages, termination or discrimination.

  • To abide by the employee's contract when they sign the employment offer.

  • Companies may negotiate a severance payment in exchange for a release of claims.

  • Companies may offer compensation to a separating employee based on their goodwill.

What is a severance agreement?

A severance agreement is a binding contract that lists the benefits employees may receive on their termination, along with any rules or conditions the company may require them to follow upon leaving the company. While each company follows a unique process, the severance agreement helps ensure that both the employee and employer reach a satisfying agreement to part ways professionally. Here are the main components of a typical severance agreement:

  • Reason for separation: Employers usually begin the severance agreement with their reason for asking an employee to resign.

  • Timeline: The agreement highlight details such as the employee's hiring date, termination date and the duration within which the employee has to accept or reject the offer in the severance agreement.

  • Pay: Severance payment is generally the most significant component of the severance agreement.

  • Other benefits: Compensation for unused annual leave, sick leave and paid time off may also be part of the severance package. Agreeing to continue insurance coverage is another essential benefit and can offer stability for employees as they look for a new employer.

  • Transition help: Employers can offer transition services to help departing employees find new employment. They usually serve as references or write recommendation letters for terminated employees.

  • Return of company equipment: If the employee has any company property in their possession, the severance agreement may explain how and when to return it. This ensures a peaceful transition while terminating an employee.

  • Non-compete clause: A severance agreement may also include certain restrictions or rules. An example is a non-compete clause requiring the employee to wait a set period before applying for work with competitors.

  • Non-disparagement clause: This clause explains that the employee can't spread any negative news or information about the employer for a certain period.

Related: How to Write a Short Resignation Letter (With Template and Examples)

Calculating severance payment

A typical severance package may compute compensation based on the employee's years of service for the company. Here's a generic formula to compute severance payment:

  • Monthly paid employees: For monthly paid employees, companies calculate their severance amount as two-thirds of the employee's monthly wage or two-thirds of $22,500, whichever is less, for the duration of their employment.

Severance payment = (previous month's wage x 2/3) x (years of service)

  • Daily paid employees: For daily paid employees, companies calculate their severance amount as 18 days of wages with the duration of the employee's employment.

Severance payment = (any 18 days of wages chosen by the employee) x (years of service)

As of 2022, the Employment Ordinance directs employees to request severance payment by notice to their employer within three months of termination. The employer ensures to make the payment within two months of the notice. In practice, most employers issue the amount within seven days of termination, along with other benefits and expenses.

Tips to negotiate a better severance package

Sometimes, employees can negotiate their severance package. Consider the following practices when preparing to negotiate your severance package:

  • Leverage your success: Gather suitable information regarding the duration of employment, current earnings, previous rewards for successful service and any other relevant information relevant to exhibit your value to the employer. Discuss your loyalty and hard work over the years with the company to convince them to offer a better severance package.

  • Understand components of severance package: Before negotiating the severance package, it's essential to understand every aspect clearly.

  • Be calm and confident: Enter the severance agreement discussion with the employer in a relaxed but confident demeanour.

  • Negotiate other benefits: If the employer is unwilling to increase the severance amount, try negotiating additional benefits instead. Look for any benefits or other areas such as payment for unused paid time off, which they can include in the package.

  • Get an expert opinion: Seek expert opinion from a lawyer or business mentor about the contents of the severance agreement. Based on their experience, they can identify areas where you can negotiate and earn a better package.

  • Be reasonable: Even though it may be tempting to ask for a large amount or extra benefits, making a reasonable request encourages the employer to accept it.

  • Negotiate your clauses: If there's a non-compete clause or any other related clauses in your package, you may leverage that information to increase the severance package.

  • Know your limits: If the employer rejects the negotiation request, politely accept and move on. Treat the discussion with sensitivity while maintaining confidence in what you require from the company.

Please note that none of the companies mentioned in this article are affiliated with Indeed.

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