Severance Package: An Employer Guide
Severance is not required by federal law. What a package contains, how much to offer, the tax, the OWBPA rules, and the release you are actually buying.
Severance Package
You are not required to offer one. What it contains, how much to pay, what it costs after tax, and the legal rules that decide whether the release you paid for is worth anything
You are letting somebody go, and you are wondering whether you have to pay them severance. The short answer is no. Federal law does not require it, and most small businesses that pay it are paying it for reasons they have never articulated.
That is a problem, because severance is not a gesture. It is a transaction. You are buying something specific, and if you do not know what it is, you will overpay for it, or underpay for it, or pay for it and fail to actually receive it because the paperwork was wrong.
This is the employer version: what severance is, what you are actually buying, when it is worth offering, how much, what it costs after tax, and the legal rules that determine whether the release you paid for is worth the paper it is written on. The over-40 rules of the Older Workers Benefit Protection Act (OWBPA) get extra attention, because they are not optional and employers get them wrong routinely.
I build FirstHR, which is where the agreement and the offboarding record live. A caveat that matters here more than almost anywhere: this is employment law with real legal consequences, I am not a lawyer, and a severance agreement should be reviewed by one.
What Is Severance Pay?
Severance pay is compensation an employer provides to an employee whose employment is ending, typically in a layoff or a termination without cause, and almost always in exchange for the employee signing a release of legal claims.
The word to hold onto is consideration. In contract terms, consideration is what you give in exchange for what you get. The severance is what you give. The release is what you get. That is the entire structure, and everything else in this article follows from it.
A severance package is the full set of what you offer: the cash, plus health coverage, plus whatever else. Severance pay is the cash component specifically. The terms get used interchangeably and it rarely matters, but the distinction is worth knowing when you are reading an agreement.
You Are Not Required to Pay It
No federal law requires you to pay severance. That surprises people, and it is the most important fact on the page for a business owner deciding what to do.
So when does it become required? Almost always because you promised it, and the ways you can promise it are broader than most owners realize.
| Source of obligation | Does it bind you? | Note |
|---|---|---|
| Federal law | No | The FLSA does not require severance. There is no federal mandate |
| An employment contract | Yes | If the contract promises severance, it is an enforceable contractual obligation |
| Your employee handbook | Often yes | A handbook that states a severance policy can create an enforceable expectation, depending on how it is drafted |
| An established past practice | Sometimes | If you have always paid severance in similar circumstances, that consistency can itself create an expectation |
| A collective bargaining agreement | Yes | Union agreements frequently mandate severance terms |
| State law | Rarely, but check | New Jersey mandates severance in covered mass layoffs and Maine in closings and mass layoffs at large establishments. Most states do not |
The handbook row is the one that catches small businesses. A well-meaning sentence in a handbook saying that the company will provide severance in the event of a layoff can convert a discretionary payment into a contractual one, and you will discover this at the least convenient moment. If you want to retain discretion, your employee handbook needs to say so explicitly.
What You Are Actually Buying
If severance is not required, why does anybody pay it? Because of what they get back.
You are buying a release of claims. The employee signs an agreement giving up their right to sue you for anything arising from their employment: discrimination, wrongful termination, wage claims, harassment, retaliation, the lot. That release is the asset. The severance is the price you paid for it.
The claims being released are real and they are broader than most owners picture: discrimination under Title VII, age claims under the Age Discrimination in Employment Act (ADEA), wage and hour claims, and retaliation, which is a separate cause of action that can succeed even where the underlying claim fails.
Once you see it as a purchase, the decision framework becomes obvious. Is there something worth buying? A long-tenured employee over 40 being terminated for performance after a rocky year: yes, there is real exposure, and a release is worth paying for. A junior employee resigning voluntarily to take another job: there is no plausible claim, there is nothing to release, and severance buys you nothing.
It also explains the amounts. Severance tends to scale with tenure not out of sentiment but because tenure correlates with exposure. Ten years of employment is ten years of potential claims, ten years of documented and undocumented incidents, and ten years of accumulated relationship. The release you are buying is bigger, so the price is higher.
What Is in a Package
The cash is what people mean when they say severance, but the package is broader and several of the other components cost you very little.
Three of those are worth more than they cost. A COBRA subsidy, meaning you pay their health premium for two or three months, is a large, concrete benefit to somebody who has just lost their income and is worrying about insurance, and it costs you several hundred dollars a month.
Outplacement support costs relatively little and changes the emotional register of the conversation entirely: you are not just paying them to go away, you are helping them land. And a reference commitment costs literally nothing and removes an anxiety that would otherwise sit with them for months.
The point of this list is that severance does not have to be all cash. A package of six weeks of pay plus three months of COBRA plus a written reference is meaningfully better, to the person receiving it, than eight weeks of pay alone, and it may cost you less.
A Severance Package Example
To make that concrete, here is one package end to end. The employee has five years of service at $78,000, the position was eliminated, and she is 44. The policy pays eight weeks at that tenure, and her weekly pay is $1,500, so the gross severance is $12,000.
Around that cash sit three months of subsidized COBRA at about $750 a month, and a written reference commitment covering her dates, her title, and the fact that the role was eliminated. Her accrued PTO is paid in the final paycheck, separately and unconditionally, because it is wages she already earned.
Because she is over 40 and the company has more than 20 employees, the agreement names the ADEA, advises her in writing to consult an attorney, and allows 21 days to consider it plus 7 days to revoke. She signs on day nine, the revocation window closes, and payroll runs the $12,000, which lands as about $7,842 after withholding.
When to Offer One
Apply the purchase framing and the answer becomes clear in most cases.
The red rows are the ones to look at carefully, because they describe payments made for emotional rather than commercial reasons, and they are the ones small business owners actually make.
Paying because you feel guilty is understandable and it is not a good basis for a decision. Guilt is a real feeling and it deserves acknowledgment, but it does not generate a legal claim, and a payment made to relieve your own discomfort buys you nothing except the discomfort of having spent the money.
Keep in mind that most US employment is at-will, which means you generally do not need a reason to terminate. That does not mean you are safe: at-will does not protect you from a discrimination claim, and it is precisely that residual exposure that a release is buying off.
And ad-hoc severance is itself a risk, which is counterintuitive. If you decide case by case, with no written criteria, you are making discretionary payment decisions about individual people, and if the pattern of who gets what happens to track age or sex or race, you have created a discrimination problem out of an act of kindness. Consistency is the protection.
How Much to Offer
A common rule of thumb is one to two weeks of pay per year of service. It is a rule of thumb, not a legal requirement, and outside the New Jersey and Maine mandates there is no legal minimum.
The few laws that do set a rate stay inside that range. New Jersey and Maine both mandate one week of pay per year of service, and according to the Office of Personnel Management, federal employees separated involuntarily get one week of basic pay for each of their first 10 years and two weeks for each year beyond that.
Two structural decisions matter more than the specific number.
Set a cap. One to two weeks per year is fine at three years and becomes very expensive at twenty. Decide, in your policy, whether the formula caps out, and at what. Decide it before you have a twenty-year employee in front of you, because deciding it while looking at a specific person is how policies get abandoned.
Decide the formula in advance. This is the single most useful thing in this section. A number arrived at in the room, under emotional pressure, in a difficult conversation, is a number you will second-guess and possibly regret. A number produced by a policy you wrote calmly six months ago is a number you can defend, to the employee and to yourself.
How It Actually Works
Offering severance follows a fixed sequence, and the order has legal consequences: get it wrong and you invalidate the thing you paid for. Here are the steps, in order.
Step seven is the one employers actually get wrong. The instinct is to pay immediately, because it feels kind and because you want the whole thing over. Do not. The agreement is not in force until the revocation window closes, and paying before it does means you handed over the consideration before you owned the release.
Severance is also separate from the final paycheck, and the distinction is not cosmetic. The final paycheck is wages you already owe, it has a state-mandated deadline that in some states is immediate, and it is not conditional on anything. Making the final paycheck contingent on signing a release is unlawful: you are withholding wages the employee is already entitled to.
The Over-40 Rules
If the employee is 40 or over and you have 20 or more employees, a whole set of federal requirements attaches to the release, and failing any of them makes the waiver unenforceable. This is the section that decides whether the money you spent bought anything.
Read that last sentence again, because it is genuinely counterintuitive. The employee cannot waive the revocation period even if they want to. Somebody who says "I have read it, I am happy, let me sign now and get paid" can sign, but the seven days still run, and the money should not move until they have.
Three further points that catch employers out.
Material changes restart the clock. If the employee negotiates and you improve the offer, the 21 or 45 days start again from the date of the revised offer unless the two of you agreed in advance that changes would not restart it. A concession you made to be helpful can otherwise add three weeks to the process.
Group terminations require disclosure. Under the EEOC's rule, a group program exists once you offer severance for a release to two or more employees in the same layoff, whatever their ages. Each of them who is 40 or over must then get written information about the decisional unit, meaning the part of the business from which you chose who would get an offer.
That disclosure lists the job titles and ages of everyone eligible or selected, and the ages of everyone in the same job classification or unit who was not. It is a real document with real content, and it is frequently overlooked entirely.
You cannot bar them from the EEOC. A release may not prohibit an employee from filing a charge with the EEOC or from participating in an EEOC investigation. A clause purporting to do so is unenforceable, and the EEOC treats extracting that promise as unlawful retaliation. This is covered in the ADEA and the EEOC is explicit about it.
How It Is Taxed
Severance is wages. Not a settlement, not a gift, not tax-free. It runs through payroll and it is taxed accordingly.
Two practical consequences. First, tell them what it will actually be worth. Say the gross figure, and say plainly that it is taxed like wages. Somebody who hears $12,000 in the meeting and then sees $7,842 arrive feels badly treated a second time, on top of losing the job.
Second, it costs you more than the headline. A $12,000 severance payment costs $12,918 once your matching FICA is added.
Health Coverage
Losing a job means losing health insurance, and for most Americans that is the scariest part of the whole experience. That makes it the cheapest place to be genuinely generous.
COBRA gives a departing employee the right to continue their group health coverage for a period after employment ends, at their own expense. If you have 20 or more employees, you are generally required to offer it.
The catch for the employee is the price. According to the Department of Labor, the health plan may charge them up to 102 percent of the cost of the coverage, which is often startlingly expensive to somebody who has just lost their income.
| Option | What it costs you | What it is worth to them |
|---|---|---|
| Offer COBRA, they pay | Nothing. Just the administration | The right to keep coverage, at a price they may not be able to afford |
| Subsidize COBRA for 2-3 months | About $750 a month for single coverage | Enormous. It removes the most frightening part of losing a job |
| Subsidize for the severance period | More, but predictable | Aligns coverage with the runway you gave them, which is coherent and generous |
| Nothing beyond the legal minimum | Nothing | Nothing. Which is a legitimate choice, but be aware of what it signals |
What that subsidy costs you is knowable. According to the federal Medical Expenditure Panel Survey Insurance Component (2025), the average annual premium for single coverage at a private employer is $9,025, which is about $750 a month. Three months of it is roughly $2,250.
The second row is the one I would push. Paying somebody's health premium for two or three months costs you very little and it is the single most valuable thing in the package to the person receiving it. Cash gets spent and forgotten. Health coverage during a job search is remembered.
COBRA is also a legal obligation of its own, separate from severance: if you have 20 or more employees, you generally must offer continuation coverage whether or not you offer severance, and the notice requirements have deadlines. Details are with the Employee Benefits Security Administration.
What It Really Costs
The severance figure is not the cost of the severance. Here is the whole thing, for a five-year employee earning $78,000.
Two things to take from that. The cash line is about 70 percent of the total. Employer FICA, a COBRA subsidy, the PTO payout, and legal review all sit on top, and a business that budgets only the headline number is out by several thousand dollars.
And the last row is the entire argument. According to SHRM (2026), a single employment claim can cost $25,000 to more than $250,000 in defense costs alone, before any settlement, and it consumes a year of your attention. The release you are buying for $17,000 is insurance against that, and seen that way, the decision is usually straightforward.
The legal review line is the one people cut, and it is the one that determines whether everything above it was wasted. A defective release means you paid the $17,000 and bought nothing at all.
The State Layer
Federal law is the floor and it is a low one: no severance requirement at all. The state layer is where the actual obligations live, and they vary considerably.
| What varies by state | Why it matters to you |
|---|---|
| Whether severance is ever mandated | New Jersey requires it in covered mass layoffs and Maine in closings and mass layoffs at large establishments. Most states do not |
| Final paycheck deadlines | Some states require final wages immediately on termination. That is a separate, unconditional obligation from any severance |
| Accrued PTO payout | Several states treat accrued vacation as earned wages that must be paid out. Others leave it to your policy |
| Mini-WARN laws | Lower headcount thresholds and longer notice periods than the federal WARN Act. These reach small employers |
| Unemployment treatment of severance | Some states treat it as disqualifying wages, some do not, and some distinguish lump sum from continuation |
| Enforceability of non-disparagement | Increasingly restricted. A clause that is standard in one state may be void in another |
| Wage deduction rules | Which govern what you may and may not withhold from a final paycheck. Generally: very little |
The row that matters most operationally is the second one. Final paycheck deadlines are state law and they can be immediate. That obligation exists regardless of whether you offer severance, it is not conditional on anything, and it is the one you are most likely to breach by accident because you were focused on the package.
And the last row is worth understanding before you draft anything: in most states you may withhold essentially nothing from a final paycheck without written authorization. If somebody owes you money, a laptop, or a training reimbursement, you generally cannot simply deduct it. That is a separate conversation and often a separate legal problem.
Unemployment Benefits
Whether severance affects unemployment benefits depends entirely on the state. Departing employees will ask you about it, so it is worth knowing the shape of the answer, even though the answer is unsatisfying.
Some states treat severance as wages that delay or reduce benefits for the weeks the severance is meant to cover. Others treat it as a separate payment with no effect on eligibility at all. Some distinguish between a lump sum and salary continuation, treating them differently.
Unemployment insurance is a federal-state program, which is why the answer moves with the state line. The Department of Labor describes it as paying workers unemployed through no fault of their own as determined under state law, so each state sets its own rules about what severance does to a claim.
Your own unemployment insurance rate is separately affected by claims. State unemployment tax (SUTA) is experience-rated, meaning claims by former employees can push your rate up, so a layoff has a cost to you beyond the severance.
The honest thing to tell an employee is that it depends on the state, and that they should check with the state unemployment agency rather than rely on you. Do not guess, and do not reassure them that it will be fine, because if you are wrong they will have relied on you and been harmed by it.
What you can control is the structure. If your state treats a lump sum differently from salary continuation, that is a choice you get to make, and it may be worth making deliberately rather than by default. It is worth a five-minute conversation with your accountant before you decide the payment mechanics.
The WARN Act
If you are laying off a group rather than one person, a separate law comes into play: the Worker Adjustment and Retraining Notification (WARN) Act, which employers conflate with severance constantly.
WARN is a notice law, not a severance law. It requires you to give affected employees advance written notice of a mass layoff or plant closing. It does not require you to pay them severance, and satisfying WARN does not satisfy any severance obligation, because there usually is not one.
The federal WARN Act applies to employers with 100 or more employees not counting part-time staff, or 100 or more employees who together work at least 4,000 hours a week excluding overtime (29 U.S.C. 2101). It covers plant closings and mass layoffs, never an individual termination, which means most small businesses are outside it entirely. That is the good news.
The less good news is that several states have their own mini-WARN laws with lower thresholds. Some reach employers with far fewer than 100 employees, and some require longer notice periods.
Beyond notice, two states mandate severance in covered layoffs and closings: New Jersey, and Maine under 26 M.R.S. 625-B, which sets one week of pay per year of service for employees with at least three years at the establishment. If you are planning any kind of group reduction, check rather than assume.
The penalty for missing required notice is back pay, which lands like an unplanned severance you did not budget for. Under 29 U.S.C. 2104 it runs for each day of the violation, capped at 60 days or half the days the employee worked for you, whichever is smaller.
The Conversation Itself
The package is a document. The conversation is what the person remembers for the rest of their life. Severance guides rarely mention it, yet it is the part you will actually think about at three in the morning.
The conversation is the part only you can handle. The rest of the exit, meaning the equipment, the accounts, the handover, and the final pay calculation, belongs on an offboarding checklist rather than being remembered under pressure on the day.
Of the seven steps, step two is the one I would insist on hardest, and it is counterintuitive. Say it in the first thirty seconds. Every instinct tells you to soften the landing: ask how they are, mention the weather, work up to it gently. Do not.
An employee who walks into a meeting they did not schedule, with you and possibly another person, already knows. Everything you say before the sentence is torture, and it is torture you are inflicting to make yourself more comfortable.
Step six is legal as well as humane. If you have 20 or more employees, a person 40 or over is entitled to at least 21 days, and a waiver signed under pressure may not hold. And even if they are 25, asking somebody to execute a legal release of all claims while they are in shock is the kind of thing that gets an agreement challenged, and deserves to.
Step seven costs nothing at all. Within about ninety seconds of being terminated, somebody is already thinking about what you will say to their next employer. Telling them exactly what you will say, before they have to ask, is worth more to them than several thousand dollars of severance.
If They Push Back
Some employees will push back. Some will have consulted a lawyer, and a few will come back with a counteroffer. Here is what each response usually means and how to answer it.
| What they say | What it means | How to respond |
|---|---|---|
| I want more money | A normal opening. Often just an ask | You can hold, or move. If you move, know that for anyone 40 or over at an employer with 20 or more employees, a material change restarts the consideration clock |
| I have spoken to a lawyer | They are taking it seriously. So should you | Do not panic and do not improvise. Talk to your own attorney before responding to anything |
| I want the non-disparagement clause removed | Increasingly common, and increasingly reasonable | Broad non-disparagement and confidentiality clauses have come under real legal scrutiny. This is worth taking advice on |
| I want longer COBRA coverage | Usually a cheap ask to grant | Frequently the best trade available. Cheaper than cash and worth more to them |
| I want a better reference | Costs you nothing and means a lot | Grant it if it is honest. Refusing a reasonable reference over a severance negotiation is a bad look and a bad trade |
| I am not signing anything | Their right. You keep the money | Then you owe them their final wages and nothing else. The severance was conditional on the release, and there is no release |
The last row is the one people forget. If they refuse to sign, you do not pay the severance. That is not punishment; it is the deal. The severance was consideration for the release. No release, no consideration. You still owe every cent of their earned wages, which is unconditional, but the package was an offer and offers can be declined.
Understand the clock-restart point in the first row before you negotiate, not during. If you have 20 or more employees, a material change to the offer restarts the 21- or 45-day consideration period for anybody 40 or over. An improvement you offer to be generous can add three weeks to the process, so decide whether that is acceptable before you make the concession rather than discovering it afterwards.
The non-disparagement row has a specific source behind it. In McLaren Macomb (February 2023) the National Labor Relations Board held that offering a severance agreement with broad confidentiality and non-disparagement terms to non-supervisory employees violates Section 8(a)(1), the labor-law provision that bars employers from interfering with workers' rights to organize and act together. That decision still stands, though the NLRB General Counsel has asked the Board to overrule it. Have counsel look at your clause before you rely on it.
Write the Policy First
Write your severance policy before anybody needs it. Of everything in this article, it does the most good for the least effort, and it takes an afternoon.
A policy converts an emotionally loaded, high-stakes, individual decision into an administrative one. Without it, you are deciding what somebody's exit is worth while sitting across from them, which is the worst possible circumstance in which to make a financial decision.
The first drawback on that list is the one to be careful about. A policy that says the company will pay severance can create an enforceable obligation. If you want to retain discretion, the policy must say so explicitly: that severance is offered at the company's sole discretion, that the policy does not create a contractual right, and that the company may amend or withdraw it.
Have an attorney review the policy language for exactly this reason. It is the difference between a helpful internal guideline and an accidental promise.
The Agreement
I want to be unusually blunt about this one: do not draft it yourself. A severance agreement is the one document in a small business where the cost of getting it wrong is total, and where a few hundred dollars of legal review is unambiguously worth it. Start from a drafted version and have counsel adapt it.
What the agreement cannot do is prove you followed the sequence. That is a separate internal record, and it is the thing an enforceable release actually rests on: which offer started the clock, when they signed, when the revocation window closed, and that no money moved before it did. Fill in each date on the day it happens, because none of it can be reconstructed afterwards, and keep the record with the signed agreement.
The final wages block deserves emphasis because it is the error with the clearest legal consequence. Final wages are not conditional on a release. The employee is entitled to their earned wages and, in many states, their accrued PTO, whether or not they sign anything. If your agreement implies otherwise, or if you hold the final paycheck hostage to a signature, you have committed a wage violation on top of whatever else was happening.
The whole sequence belongs inside your employee exit process, and the signed agreement itself belongs in the personnel file, retrievable, dated, and unchanged.
Lump Sum or Continuation
You can pay severance as one lump sum or as salary continuation. It is the same total money delivered two ways, and the choice has consequences that are not obvious.
The lump sum is cleaner and it is what most small businesses should do. One payment, after the revocation period, and the relationship is over. Salary continuation keeps somebody attached to your payroll for months, which means somebody has to remember to run it, and it means the relationship does not actually end when everybody thought it did.
But continuation is materially easier on cash flow, and for a small business writing a five-figure check in a difficult month, that is not a trivial consideration. If you go that route, the agreement must answer the questions the structure raises: are they still an employee, are they still on the health plan, does PTO accrue, and what happens if they get another job before the payments finish.
And the unemployment interaction is genuinely worth a phone call. Some states treat salary continuation as disqualifying wages while treating a lump sum differently, or the reverse. That materially affects the employee, they will find out, and if you chose the structure without thinking about it, they will reasonably ask why.
What You Can Say
You offered a reference commitment, and now somebody has called. What are you actually allowed to say? Dates and job title are always safe, honest praise is low risk, and a negative assessment is where the real risk sits.
| What you can say | Risk level | Note |
|---|---|---|
| Dates of employment | None | Factual, verifiable, and universally safe. The neutral reference baseline |
| Job title and duties | None | Also factual. This plus dates is what most large companies limit themselves to |
| Whether they are eligible for rehire | Low | A common and useful signal. Answer it consistently or not at all, because inconsistency is where risk enters |
| Salary | Low, but consider | Some states now restrict discussing prior compensation. Increasingly, do not volunteer it |
| A positive assessment | Low, if honest | Praising somebody genuinely is safe. It is the negative that carries risk |
| A negative assessment | Real risk | Truth is generally a defense, but defamation claims arising from references are a real category. Be careful, and be factual |
| Why they left | Depends entirely | If you agreed to say it was a layoff, say that. Contradicting what you promised in the agreement is a breach of the agreement |
The salary row is worth a note: a growing number of states bar an employer from asking a job applicant about prior pay, for the reasons set out in pay equity. The caller usually should not be asking, and volunteering somebody's old salary is a bad idea whether or not they do.
The pragmatic answer, and what most employers land on: a neutral reference, meaning dates and title, plus whatever positive statements you honestly hold and agreed to make. It is defensible, it is consistent, and it does not require you to make a judgment call under pressure from a stranger on the phone.
The critical point is the last row. If your severance agreement says you will describe the departure as a layoff, then it is a layoff, forever. Contradicting that later is a breach of the agreement you signed, and it hands the former employee a claim you had specifically paid to eliminate.
Whatever you decide, decide it once and tell everyone. A reference policy that lives in one person's head produces inconsistency, and inconsistency is where every reference-related legal problem starts.
Situations That Come Up
Six scenarios that are not covered anywhere else and that you will eventually meet.
| The situation | What to do |
|---|---|
| They die before the severance is paid | The obligation generally survives and passes to their estate. Talk to your accountant about the tax treatment, which changes depending on the timing |
| The business is closing and money is short | In bankruptcy, wages and severance earned in the 180 days before filing are a priority claim, capped at $17,150 per employee. Get advice before promising anything you cannot pay |
| They find a new job during salary continuation | Unless your agreement says the payments stop, they do not. Decide this in advance and say so, because it is a question you will be asked |
| You want to rehire them later | The release covers claims up to the date of signing. It does not prevent you rehiring them, and it does not release future claims. Rehiring is allowed and it is not unusual |
| They ask for a non-compete to be removed | Increasingly reasonable, and increasingly doubtful to enforce. Non-competes have come under significant legal pressure. Take advice rather than defaulting to keeping it |
| They sign, then try to revoke on day 8 | Too late, unless your own agreement gave them longer than the 7-day minimum. The parties cannot shorten that window, but an employer may offer more. Check that your dates are right, because a mistake in the timeline is your problem not theirs |
The rehire row surprises people. Hiring back somebody you paid severance to is allowed, it is not unusual, and it does not undo the release, because the release only ever covered claims up to the date of signing. Anything that happens after signing sits outside it.
The business-closing row is the one worth taking most seriously if it applies to you, and it is the one nobody plans for. Do not promise severance you may not be able to pay, because an obligation you cannot meet is a debt owed to somebody who now has a claim against a business with no money.
Bankruptcy gives that claim a rank rather than a guarantee. Under 11 U.S.C. 507, wages and severance earned in the 180 days before the filing are a fourth-priority claim capped at $17,150 per employee, and anything above the cap waits behind the priority creditors.
And the non-compete row is moving fast. Broad non-compete clauses have come under sustained legal pressure, and a clause that was standard practice a few years ago may now be unenforceable or restricted where you operate. If somebody asks for it out, that is worth a genuine conversation with counsel rather than a reflexive no.
Alternatives to Severance
Sometimes the right answer is not a severance package at all, and it is worth knowing the alternatives before you default to writing a check.
| Alternative | When it fits | The catch |
|---|---|---|
| Pay in lieu of notice | You want them gone today but owe notice | Not the same as severance. It buys no release and it is simply wages for a notice period you are not making them work |
| A longer notice period | You can afford the runway and they can keep working | They stay on payroll, keep their benefits, and job-hunt. Cheaper than it looks, and it buys goodwill without a legal document |
| Salary continuation instead of a lump sum | Cash flow matters, or your state treats it better for unemployment | Same total money, spread out. Check how your state treats each for unemployment purposes before you choose |
| Extending health coverage only | The cash is not the problem, the insurance is | Often the single most valuable thing you can offer, and far cheaper than the equivalent in cash |
| A performance improvement plan | You genuinely want to keep them | Not an alternative to severance so much as an alternative to termination. Only honest if you actually mean it |
| Nothing at all | Clean departure, no exposure, no promise made | Entirely legitimate. You are not required to pay severance, and paying it where there is nothing to buy is simply a gift |
The last row deserves to be stated without embarrassment. Offering nothing is a legitimate choice. If somebody resigned voluntarily, on good terms, with no plausible claim against you, then there is no release worth purchasing and severance would be a gift rather than a transaction. That is allowed, it is normal, and it is what most small businesses do most of the time.
The second row is underrated. A longer notice period is frequently better for everybody than a shorter one plus severance. They stay employed, they keep their health coverage, they job-hunt from a position of employment rather than unemployment, and it often costs you less than the equivalent severance would.
A longer notice period does not buy you a release, though, so it is not a substitute where there is real legal exposure. But where the risk is low and the goodwill matters, it is a genuinely good option that almost nobody considers.
Common Mistakes
Seven recurring failures, and several of them mean you paid the money and bought nothing.
The two that cost the most are the OWBPA failures and the missing release, and they share a shape: you spent the money and did not get the thing. Every other mistake on that list is recoverable. Those two are a total loss, and you find out about them at the worst possible moment, which is when somebody is already suing you.
If You Were Offered One
Most of this page is written for the employer. But a great many people arrive at a page like this because they have just been handed a severance agreement, and it would be strange to send them away with nothing. So here is the honest version, from the other side of the desk.
The single most useful thing to understand, if you are the one holding the agreement, is the same thing the employer needs to understand: this is a purchase. They are buying your right to sue them. Whether the price is fair depends entirely on what those rights were worth, and that is a question for a lawyer rather than for a blog post.
And the pressure to decide quickly, if you are feeling any, is worth noticing. You have time. If you are 40 or over and your employer has 20 or more employees, the law guarantees it, and at any age you can take the agreement home and read it. An employer who is rushing you is telling you something.
Frequently Asked Questions
What is severance pay?
Severance pay is money an employer pays a departing employee on top of the wages they have already earned, most often when a role is cut in a layoff or someone is let go without cause. In practice it almost always comes tied to a release: the employee agrees not to bring legal claims against the company, and the payment is what they receive in return. No federal law requires it. The Fair Labor Standards Act has no severance requirement, and the Department of Labor treats severance as a matter of agreement between employer and employee. It becomes an obligation when a contract, an employee handbook, or a company policy promises it, or where a state layoff mandate applies, as in New Jersey and Maine.
What is the severance pay meaning in simple terms?
It is money your employer pays you when your job ends, usually because the role was eliminated rather than because you did anything wrong. In most cases it is not something they owe you by law; it becomes owed only if a contract, a company policy, or a state layoff mandate such as New Jersey’s or Maine’s requires it. It is a payment offered in exchange for you signing an agreement that you will not sue them. That is the actual transaction: money for a release. Understanding that reframes the whole thing, because it explains why severance is offered, why an agreement almost always comes with it, and why an employer who is not worried about a claim often does not offer any.
Is severance pay required by law?
No, not under federal law, and most states do not require it either. The Fair Labor Standards Act contains no severance requirement, and the Department of Labor describes severance as a matter of agreement between an employer and an employee. It becomes an obligation once you promise it, whether in a written employment contract, an employee handbook, an established policy, or a collective bargaining agreement. Two states add mandates of their own. New Jersey requires one week of pay per full year of service in covered mass layoffs at employers with 100 or more employees, and Maine requires one week’s pay per year of service for employees with at least three years at an establishment of 100 or more that closes or has a mass layoff. Outside those cases, whether to pay is your call.
What is a severance package?
A severance package is everything an employer offers a departing employee when a job ends, and severance pay, the cash, is only one part of it. A package often adds continued health coverage or a subsidy toward COBRA premiums, sometimes outplacement or career support, and a commitment about what the employer will say to a reference caller. In exchange, the employee signs a release of legal claims arising from the employment. That release is what the employer is actually buying, and everything else in the package is the consideration paid for it. Accrued PTO that state law or your own policy requires you to pay out is a separate matter: it belongs in the final paycheck, not in the package.
How much is severance pay?
No law sets a minimum for a private employer’s voluntary severance, so the amount is whatever your policy or your offer says. A common rule of thumb is one to two weeks of pay for every year of service, which would put someone with four years at four to eight weeks. Treat it as a rule of thumb rather than a measured standard. Where a statute does fix a rate, it sits at the bottom of that range: New Jersey’s mass layoff mandate and Maine’s closing and mass layoff mandate both use one week of pay per year of service. Executive severance is often set in the employment agreement negotiated at hire rather than by a tenure formula. More important than any benchmark is fixing your own formula, and a cap, in a written policy before you need it, so the number is not improvised in the room and every comparable separation gets the same treatment.
How do severance packages work?
A severance package works as an exchange: the employer offers money and benefits, and the employee signs a written release of legal claims in return. The employer decides to end the employment, prepares the package and the agreement, and presents both in writing at the termination meeting. The employee then gets time to consider it. If they are 40 or over and the employer has 20 or more employees, federal law sets that time at a minimum of 21 days, or 45 days in a group termination, followed by 7 days to revoke after signing. Once the revocation period has passed, the agreement takes effect, and the employer pays the severance through payroll as wages, with income tax withholding and FICA on both sides.
Is severance pay taxed?
Yes, severance pay is taxed in full as wages. It is not a settlement and it is not tax-free. IRS Publication 15 lists severance pay among supplemental wages, so when it is paid separately from regular wages the employer may withhold federal income tax at a flat 22 percent, rising to a mandatory 37 percent on supplemental wages above $1 million in a calendar year. Social Security and Medicare apply exactly as they do to regular pay, and the Supreme Court confirmed in United States v. Quality Stores (2014) that severance paid to terminated employees is wages for FICA. The employer owes its matching share on top. With flat federal withholding, FICA, and an illustrative state income tax, a $12,000 severance payment lands as about $7,842 and costs the employer about $12,918, before any COBRA subsidy or legal review. Tell the employee up front that the gross figure is taxed like wages, so the net amount does not come as a second shock.
Do I have to give an employee 21 days to sign a severance agreement?
Yes, if the employee is 40 or over, you have 20 or more employees, and the agreement waives age discrimination claims. The Older Workers Benefit Protection Act requires at least 21 days to consider the agreement, or 45 days when it is offered as part of a group termination program, and at least 7 days after signing to revoke. The parties cannot shorten the revocation period, by agreement or otherwise, even at the employee’s request. The employee may sign sooner if the choice is knowing and voluntary. Miss any of these requirements and the waiver of age claims cannot be enforced, so the severance you paid buys you nothing on that front. For employees under 40, or at employers below 20 employees, federal law sets no minimum period.
Can I pay severance before the revocation period ends?
You should not. No rule forbids an early payment outright, but it is a mistake employers genuinely make. For an employee 40 or over at an employer with 20 or more employees, the OWBPA makes the agreement neither effective nor enforceable until the 7-day revocation period has expired. Paying the severance before that point undermines the entire structure: the agreement is not yet in force, and you have handed over the consideration before securing the release, while the employee can still revoke. The correct sequence is that the employee signs, the 7 days run, the agreement becomes effective, and then you pay on the next payroll run. Put the revocation end date in your records so payroll knows the earliest day the money may move.
Does severance affect unemployment benefits?
It can, and the answer turns entirely on your state. In some states, severance counts as wages, so unemployment benefits are delayed or reduced for the weeks the payment is meant to cover. In others, it is treated as a separate kind of payment with no bearing on whether the person qualifies. A third group looks at how it was paid and handles a lump sum differently from salary continuation. The question matters more to the employee than to you, but expect to be asked. The honest reply is that it varies by state and that they should confirm with the state unemployment agency instead of relying on your answer. If your state treats the two payment structures differently, choose between them deliberately.
Should a small business offer severance?
Yes when there is something to buy, and no when there is not. Severance is a transaction: money in exchange for a release of claims. If the departure is clean, the employee resigned, and there is no plausible claim, there is nothing to release and a payment is a gift. If there is real exposure, for example a long-tenured employee, a performance exit with thin documentation, or anyone 40 or over, a few weeks of pay against a properly executed release is inexpensive next to the legal fees of defending a claim. Where the risk is low but goodwill matters, a longer notice period can do some of the same work for less, although it buys no release.
What is the difference between severance pay and a final paycheck?
The final paycheck is wages you already owe, while severance is an additional payment you choose to offer in exchange for a release. The final paycheck covers hours worked, any expenses owed, and accrued PTO where your state or your own policy requires a payout. It is legally required, it is unconditional, and state law sets its deadline, which in some states is the day of termination. Severance is optional unless a contract, a policy, or a state layoff mandate requires it, and it is conditional on the employee signing the agreement. Keep the two apart. Making the final paycheck conditional on signing a release withholds wages the employee is already entitled to, which is a wage violation, and under the OWBPA money the employee is already owed cannot count as the consideration for an age claim waiver. Pay final wages on the state deadline whether or not the agreement is ever signed, and pay the severance only after the agreement takes effect.
Do I have to offer severance to everyone equally?
Not identically, but consistently. Structuring packages by tenure and seniority is legitimate. What is not legitimate is a pattern in which the decision to offer severance at all, or how generous it is, tracks age, sex, race, or another protected characteristic. Ad-hoc severance decided case by case is itself a discrimination risk, because you are making discretionary payment decisions about individuals with no stated criteria. A written policy with a formula and a cap, applied the same way to every comparable separation, is both fairer and far safer. When an employer with 20 or more employees offers severance for a release to two or more people in the same layoff, consistency also has a paperwork side: each of them who is 40 or over must receive written disclosure of the job titles and ages in the decisional unit.
What is the WARN Act and is it the same as severance?
No. They are separate laws, and employers mix them up constantly. The federal WARN Act governs notice only: a covered employer must give affected employees 60 days of written notice before a mass layoff or plant closing. Nothing in it obliges you to pay severance. Federal WARN covers employers with 100 or more employees, leaving part-time staff out of the count, or 100 or more whose combined hours reach at least 4,000 a week excluding overtime, and only a mass layoff or plant closing triggers it. That puts most small businesses outside it. State mini-WARN laws are another matter: several set lower headcount thresholds and longer notice periods, so they can reach much smaller employers, and New Jersey’s also requires severance in covered mass layoffs. Check yours before any group reduction.
Do I have to pay out accrued PTO in a severance?
That depends on your state and your policy, and it is a separate question from severance. In several states, accrued but unused vacation is treated as earned wages that must be paid out at separation whatever your policy says. Elsewhere, payout generally turns on what your own policy promises. Either way, accrued PTO owed under state law or your policy belongs in the final paycheck, not in the severance package, and it is not conditional on signing a release. It also cannot double as the price of the release: for an employee 40 or over at an employer with 20 or more employees, the OWBPA requires consideration beyond anything already owed, and PTO you must pay out is already owed.
How much does a severance package really cost?
More than the headline. A $12,000 severance for a five-year employee also carries about $918 in employer FICA, because severance is wages. Add a COBRA subsidy for three months at about $750 a month, any accrued PTO payout owed under your state’s rules or your policy, and roughly $500 to $1,500 for a lawyer to review the agreement, and the real cost of the exit lands closer to $17,000. Weigh that against the cost of defending a single employment claim, which SHRM puts at $25,000 to more than $250,000 in defense costs alone, before any settlement. Seen that way, it is usually a straightforward trade, provided the release is drafted correctly and actually holds.
What if the employee refuses to sign the severance agreement?
Then you do not pay the severance. That is not a penalty; it is simply how the deal is built. Severance is the price offered for a release of claims, and if there is no release, there is nothing to pay for. That holds for voluntary severance; a payment that a contract or a state layoff mandate requires regardless of any release is a different matter. What you still owe, unconditionally, is their final paycheck: earned wages and, in many states, accrued PTO. Those are not contingent on anything, and withholding them pending a signature would be a wage violation regardless of what the severance agreement says. Pay final wages on your state’s deadline whether or not the agreement comes back.
Should I sign a severance agreement?
It depends on what you are giving up and what you are getting, and it is genuinely a question for an employment lawyer rather than for an article. The core trade is that you receive money and benefits in exchange for giving up your right to sue your employer over claims arising from the employment up to the date you sign. If you have no plausible claim, that is an easy trade. If you believe you were discriminated against, wrongfully terminated, or underpaid, you are being asked to sell something that may be worth considerably more than the severance. Do not sign under time pressure: if you are 40 or over and your employer has 20 or more employees, federal law guarantees you at least 21 days.
How long do I have to decide on a severance offer?
If you are 40 or over and your employer has 20 or more employees, federal law gives you at least 21 days to consider the agreement, or 45 days if it is part of a group termination. You then have a further 7 days after signing during which you may revoke, and nobody can shorten that revocation period, including you. If you are under 40, or your employer has fewer than 20 employees, there is no federally mandated period, although state law may add protections. An employer pressuring you to sign immediately is worth being wary of. Whatever your age, you are allowed to take the agreement home and read it before deciding.
Can I negotiate a severance package?
Yes, and many people do. The worst realistic outcome is that the employer declines. Reasonable asks include a longer COBRA subsidy, which usually costs the employer little and is worth a great deal to you, a more favorable reference, and removal of an unusually broad non-disparagement clause. Asking for more cash is also normal. Be aware that if you are 40 or over, the employer has 20 or more employees, and it materially changes the offer, the consideration period restarts from the revised offer unless you both agreed in advance that changes would not restart it. That lengthens the process, but it also gives you more time to decide.
Is my severance offer a good one?
Start by comparing it with a common rule of thumb: one to two weeks of pay per year of service, which would put someone with five years at five to ten weeks. That is a rule of thumb rather than a measured standard, and outside the New Jersey and Maine mandates, which use one week per year, there is no legal minimum. Look at the whole package too, because a COBRA subsidy or a reference commitment can be worth more to you than a little extra cash. But the more important question is whether the amount is worth the legal claims you are being asked to release. If you believe you have a genuine claim, the benchmark is irrelevant and you should be talking to an employment lawyer.
Can my employer withhold my final paycheck if I do not sign?
No. Your final paycheck is wages you have already earned, and in many states it includes accrued unused PTO. It is owed to you whether or not you sign a severance agreement, it is not conditional on anything, and state law sets the deadline for paying it, which in some states is the day of termination. An employer who conditions your earned wages on signing a release is committing a wage violation, not taking a negotiating position. The severance is separate: that is the optional part, and it is what the release is being exchanged for. Decide on the severance on its merits, knowing the paycheck is already yours.
Can an employee negotiate a severance package?
They can ask, and some will come back with a counteroffer, sometimes after consulting a lawyer. Whether you move is your decision. The important mechanical point is that if you have 20 or more employees and you materially change the offer to an employee aged 40 or over, the OWBPA consideration period starts over from the date of the revised offer, unless you both agreed in advance that changes would not restart it. That means a negotiation can reset a 21-day or 45-day clock and extend the process considerably. Knowing that in advance lets you decide whether a small concession is worth the delay, rather than discovering it midway.