Severance Pay

Refers to the compensation or benefits that an employer offers an employee upon employment termination

Author: Adin Lykken
Adin Lykken
Adin Lykken
Consulting | Private Equity

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The Boston Consulting Group as an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

Reviewed By: Matthew Retzloff
Matthew Retzloff
Matthew Retzloff
Investment Banking | Corporate Development

Matthew started his finance career working as an investment banking analyst for Falcon Capital Partners, a healthcare IT boutique, before moving on to work for Raymond James Financial, Inc in their specialty finance coverage group in Atlanta. Matthew then started in a role in corporate development at Babcock & Wilcox before moving to a corporate development associate role with Caesars Entertainment Corporation where he currently is. Matthew provides support to Caesars' M&A processes including evaluating inbound teasers/CIMs to identify possible acquisition targets, due diligence, constructing financial models, corporate valuation, and interacting with potential acquisition targets.

Matthew has a Bachelor of Science in Accounting and Business Administration and a Bachelor of Arts in German from University of North Carolina.

Last Updated:February 12, 2024

What Is Severance Pay?

Severance pay refers to the compensation or benefits that an employer offers an employee upon employment termination.

Employers may provide severance pay in cases of mutual resignation, layoff, retirement, or other forms of separation from employment, but it is not always mandatory. Extended benefits like health insurance and outplacement support to aid an employee in finding new employment may be included in it.

Employers are not legally required to provide severance unless a contract or employee handbook specifies otherwise. Employer-sponsored benefits typically come in a lump sum and are subject to taxation.

Severance pay typically includes some or all of the following components:

  • More payments based on how many months or years you work
  • Payment of accrued but unused vacation time, sick days, and holiday pay
  • Life or health insurance and dental benefits
  • Stock options and retirement funds
  • Unemployment benefits

Key Takeaways

  • Severance pay includes compensation or benefits given to an employee upon termination, which may include health insurance, accrued vacation time, and stock options, but it's not mandatory and is subject to taxation.
  • The amount of severance pay varies based on factors like salary, tenure, position in the company, and performance, with employers often considering these elements to determine the package's value.
  • Qualifying for severance pay depends on jurisdictional regulations, tenure, and contractual obligations, with calculation methods differing between regions.
  • Severance pay benefits both employers and employees by enhancing company reputation, attracting top talent, aiding financial recovery for terminated employees, and providing time to seek new employment, ultimately improving employee satisfaction and company image.
  • While severance pay is discretionary and aims to provide additional support to terminated employees, termination pay is mandated by law. It compensates for work already completed, highlighting the distinctions between the two forms of compensation.

Factors Determining Severance Pay

The value/amount of a severance package differs from company to company and employee to employee. Employers may take into account the following factors when deciding how much severance to provide:

  • Salary and pay scale before termination: The employee's salary is also considered while deciding the amount of severance they will get in the event of termination.
  • A period of employment: It depends on when the employee has worked for the employer. However, long-term employees will eventually develop skills unique to their place of employment and, therefore, be eligible for higher pay.
  • Position in the company: An employee's position in the company's hierarchy is also important. For instance, entry-level employees may receive one month, whereas senior position employees may receive 2-3 months of pay.
  • Performance and other important variables also depend on the employee's performance throughout their job or company tenure.

It is crucial to remember that even though you might believe you deserve this pay in the event of a layoff, employers are not required to do so if it is not mentioned in the employee handbook or agreement.


Sears announced in 2018 that it would be terminating hourly workers without providing them with severance pay. In addition to announcing that it would pay its executives millions in annual bonuses while restructuring in bankruptcy, the company received harsh criticism from employees and the general public.

The Fair Labor Standards Act (FLSA) requires employers to pay fired workers through their final day of employment and any accrued vacation time, regardless of whether the employer provides severance pay.

How to Qualify for Severance Pay?

Determining eligibility for severance pay is subject to varying regulations dictated by different jurisdictions. These criteria commonly hinge on factors such as tenure, contractual obligations, and provisions established through collective bargaining agreements.

For instance, within California, USA, an individual may become eligible for severance pay provided they have served a stipulated duration with the employer, typically outlined within their employment contract, and the termination is not attributed to misconduct.

Similarly, in Ontario, Canada, eligibility for severance pay under the Employment Standards Act 2000 necessitates meeting specific conditions:

  • Having rendered service to the employer for a minimum of five years
  • The employer's payroll surpasses $2.5 million, or in cases where the company has terminated 50 or more employees within a six-month timeframe, as stipulated by Ontario's Employment Standards Act, 2000

How to Calculate the Amount of Severance Pay?

Determining severance pay involves following distinct guidelines established by different jurisdictions. Here's an overview:

1. Severance Pay in Ontario, Canada

The maximum severance pay in Ontario is capped at 26 weeks. The calculation method is as follows:

Regular weekly wages x (Completed years + Completed months / 12 for incomplete employment years)

2. Severance Pay in California, USA

In California, severance pay calculation typically considers the employee's tenure and regular pay rate. Other factors, such as company policies and contractual agreements, may also impact the final amount.

3. Severance Pay in New York, USA

Severance pay regulations in New York can vary based on factors like employer size and the reason for termination. T


The state may provide specific formulas or guidelines to determine the owed severance pay.

4. Severance Pay in British Columbia, Canada

In British Columbia, the maximum severance pay is eight weeks. It's calculated based on the following criteria:

  • After three months: One week
  • After 12 months: Two weeks
  • After three years: One week for each completed year

    Severance Pay Example

    Consider Sarah, who has been the marketing manager at a tech startup in San Francisco for the past seven years. Due to internal restructuring within the company, Sarah and several of her colleagues have received notice of their impending layoffs.

    Sarah's weekly salary amounts to $1,500, and according to her employment contract, she is entitled to one month's salary for each year of service as severance pay. Given her tenure, Sarah is eligible for severance pay equivalent to seven months' worth of salary.

    Thus, Sarah's severance pay calculation stands at:

    7 months x $1,500 = $10,500

    In this scenario, California's regulations governing severance pay determine the terms of Sarah's compensation package subsequent to her termination.

    When Does Severance Occur?

    An employee is deemed "severed" under the following circumstances:

    • The employer terminates or ceases employment with the employee due to reasons such as the company's bankruptcy or insolvency
    • The employer effectively dismisses the employee, leading to a constructive dismissal, which occurs when the employer's actions breach the employment contract or make the work environment intolerable
    • The employer lays off the employee for a period spanning a specific duration, which may vary by jurisdiction but often exceeds several weeks consecutively
    • The employer lays off the employee owing to the permanent closure of the business

    Severance Pay Advantages And Disadvantages

    These payments pose many different advantages and disadvantages.

     The advantages are more numerous than the disadvantages: 

    1. It aids the company in enhancing its reputation within the sector.
    2. Employers can recruit better candidates because increased pay encourages workers to work for the company.
    3. It is an additional benefit for the workers that aid in their financial recovery after being let go.
    4. The management has the discretion to award severance pay. Therefore, whether or not to pay the employees is up to management.
    5. Even temporarily, it gives workers more time to look for a new job or another source of income while still having money in their pockets.
    6. Because the payment of severance pay will result in employee satisfaction, the company's reputation will be improved because the employee will promote the company favorably to the public.

    Some of the disadvantages are as follows:

    1.  Employees who do not receive severance pay may face financial losses
    2. Severance pay is not universally mandated by regulation or law
    3. Providing severance pay increases costs for the company

    Severance Pay vs. Termination Pay

    While severance and termination pay have different purposes, these two terms are frequently used interchangeably. 

    Severance Pay vs. Termination Pay
    Severance Pay Termination Pay
    It is not universally mandated, and the decision and amount are typically at the employer's discretion, although legal or contractual obligations may sometimes exist.  All employers are required to provide termination pay. This payment is calculated according to the number of days of notice an employee gives before quitting their job.
    Employees do not have the right to it because it is not guaranteed unless specified in the employment contract or other written agreement.  Employees who have served their full notice period before quitting are entitled to termination pay.
    It is provided to give the employees a little more time to look for another job or another source of income. Termination pay is the pay the employee has already worked for the employer.

    Both severance and termination pay provide financial assistance to employees, but receiving it from the employer will help increase the business's positive perception because it is an additional benefit that the company would provide to its employees, except termination pay.

    Severance Pay FAQs

    Researched and authored by Purva Arora | LinkedIn

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