What is Severance Pay?

Severance pay is a payment to former employees when their jobs end, usually because they were fired, laid off, restructured, or both parties decided to end their relationship.

This guide explains what severance pay is, if severance pay is mandatory or not, what a severance package typically includes, who qualifies, how severance pay is calculated, and how severance pay is taxed. It gives HR teams and business leaders a clear, practical overview of the essentials so they can manage employment transitions confidently and consistently.

What Is Severance Pay?

Severance pay is compensation provided when employment ends, typically in situations such as layoffs, redundancy, restructuring, or a mutual separation. In practice, a severance payment may help a former employee manage expenses while searching for a new job, and it often comes coupled with other benefits like health insurance coverage or outplacement services.

It’s important to clarify that employers are not always legally obligated to provide severance pay. In many regions, including the U.S., federal law doesn’t require companies to pay severance unless it’s already promised in an employment contract, outlined in the employee handbook, or agreed upon in collective negotiations with an employee’s representative. Because of this, severance packages vary widely: most employers decide on a case-by-case basis how they will offer severance and under what conditions a departing employee receives extra compensation.

In short, severance is a form of financial relief that companies choose to offer under certain circumstances, that’s not a guaranteed entitlement. But when it's available, it's a big part of helping people who have been laid off deal with the financial effects of their loss and figure out what to do next.

Bi-monthly vs. Bi-weekly Payroll: Understand the Pros and Cons →

What Severance Pay Includes

A severance package can cover several forms of compensation and support, depending on company policy, the employment contract, and the circumstances of the termination. While severance packages vary, most employers follow a similar structure:

1. Lump-sum payment: The most common component is a lump sum based on the severance pay formula (often tied to tenure or regular wages) This severance payment is extra compensation provided once the employee receives their final check.
2. Unused PTO or vacation payouts: In many organizations, unused paid time or accrued vacation time is paid out at separation. Whether unused vacation time must be paid depends on state law or local employment law.
3. Extended benefits: Some companies extend health insurance coverage or other benefits for a certain period. This may include continued access to health insurance, training resources, or supplemental wages tied to short-term support programs.
4. Outplacement support or training: To help departing employees secure a new job, many employers offer outplacement services, career coaching, or skill-building programs.
5. Optional extras: Depending on seniority and the severance offer, packages may also include bonuses, stock options, or equity considerations. In some cases, employers add a non disclosure agreement or other conditions in exchange for additional pay.

Who Qualifies for Severance Pay?

Eligibility for severance benefits depends on the situation, the employment contract, and local laws. Companies choose to offer severance pay in several common scenarios like the following:

• Company restructuring or layoffs: Laid off employees often receive severance pay when roles are eliminated due to budget cuts, reorganizations, or facility closures.
• Job elimination: If the position disappears entirely (regardless of performance) most employers offer severance to support the former employee during the transition.
• Mutual separation agreements: In certain circumstances, both the employer and the employee agree to end the employment relationship. Mutual separation often comes with a severance agreement outlining pay, benefits, and conditions.
• Exceptions: Severance is generally not provided when an employee is terminated for cause. In these cases, employers are not legally obligated to pay severance, unless an employment contract guarantees it.
• Global considerations: Rules differ widely across countries. In some regions, employers are legally required to provide severance pay based on tenure or regular pay. In others like the U.S., federal law does not mandate severance, and eligibility is determined by company policy, collective agreements, or the employee handbook.

How Much Is Severance Pay?

There’s no universal rule for how much severance pay a former employee should receive, but many employers use a simple severance pay formula. A common approach is 1–4 weeks of regular wages for each year of service, paid as a lump sum. Seniority, role level, and the circumstances of the termination often influence where an employee falls within that range.

These factors usually determine the final amount:

• Tenure: Longer service typically results in higher severance benefits, especially when severance agreements are tied to years worked.
• Seniority: Executives or long-tenured managers may receive additional pay, extended health insurance coverage, or other benefits.
• Employment contract or collective agreements: An employment contract, union agreement, or terms negotiated by an employee's representative may specify exact severance payment rules (sometimes making the employer legally obligated to follow them).
• Company policy: Many employers outline severance expectations in the employee handbook. Others decide on a case by case basis, depending on the reason for the separation and what the company can offer.

Because severance packages vary widely, some HR teams use a severance pay calculator to model scenarios. These tools can help estimate cost and total income impacts, but calculations should always be reviewed in the context of state law, federal taxes, and internal policy. To further optimize the process, you can also try HR policy generators.

Is Severance Pay Taxable?

Yes. Severance pay is taxable in most regions. From a tax perspective, severance payment counts as supplemental wages and is generally considered taxable income, just like normal wages.

How Does Federal Income Tax Apply to Severance Pay?

Employers typically withhold federal income tax, state tax (where applicable), and social security contributions from the severance payment. Because it increases total income for the year, severance may affect an employee’s tax bracket. The final amount the employee receives after withholding can be lower than expected, so it’s important for HR teams to explain the tax implications clearly.

Here are some regional examples:

• United States: Severance pay is treated as taxable income and is subject to federal income tax, federal taxes on social security and Medicare, and most state income tax systems. Employers may withhold at a flat rate or combine it with regular pay, depending on payroll practices.
• United Kingdom: In the U.K., a portion of termination-related payments, including statutory redundancy or approved severance, is often tax-free (up to a combined threshold of £30,000). Any additional amount, or other payments such as holiday pay or notice-period pay in lieu, is typically treated as taxable income under normal withholding rules.
• European Union (general patterns): Approaches vary by country. In many EU states, severance packages are considered taxable income, while others allow partial tax relief under specific employment law provisions or certain circumstances (e.g., mandatory severance after a redundancy).

Because practices differ globally, employees should understand how income tax rules apply in their location, and employers should be transparent about how withholding will work so the employee receives accurate expectations.

The 7 HR Reports You Need Monthly →

How Severance Pay Is Calculated

As we’ve said, although severance packages vary, most employers follow a straightforward severance pay formula. The goal is to create a consistent, fair structure that reflects tenure, role, and company policy.

Step-by-step example

A common method is to base severance on weeks of regular pay:

1. Determine years of service. For instance, 6 years.
2. Apply a per-year multiplier. For instance, 2 weeks of regular wages per year of service.
3. Calculate the total. For example, 6 years × 2 weeks = 12 weeks of severance pay.
4. Convert to a lump sum (if applicable): If the employee earns $1,200 per week, the severance payment would be: 12 × $1,200 = $14,400.

Lump-sum vs. Salary Continuation

An employee who receives lump-sum severance gets paid in full all at once. This is the most common approach, but the entire payment may be considered taxable income in the year it’s received.

Under salary continuation, the employer keeps paying regular wages for a predetermined amount of time (e.g., 8–12 weeks). This may help the former employee maintain benefits such as health insurance coverage, depending on local rules.

Prorated Components and Deductions

Severance packages can also include prorated items such as partial bonuses or equity vesting if the company chooses to include them. Deductions may apply for unpaid loans, equipment not returned, or other balances the employee owes under the employment contract. Withholding for income tax and social security will also impact the final amount the employee receives.

Realistic Example

A manager with 4.5 years of service may receive:

• 3 weeks of pay per year of service
• Prorated bonus for the final quarter
• Payment for unused paid time
• Continued health insurance for a certain period

Even though tenure is 4.5 years, some employers round up or prorate the calculation, which depends on company policy and the terms of the severance agreement.

To estimate different scenarios (especially when severance packages vary across roles or locations) HR teams often use people-analytics tools. An HR metrics tool can help centralize workforce data and make severance planning more consistent.

Why Employers Offer Severance Pay

Many employers offer severance pay as a means to facilitate a smoother and more responsible separation process, rather than due to legal obligations. Here are some common reason for doing so:

• Lower the legal risk and hold on to your good name: A fair severance offer helps minimize disputes, clear up expectations, and prevent misunderstandings about the termination. It signals to departing employees that they’re being treated respectfully.
• Protect your employer brand and employee morale: How a company treats terminated employees directly affects how current employees feel and how job candidates view the organization. Providing severance pay signals stability, fairness, and long-term thinking.
• Help provide more comfortable transitions: Severance benefits (whether in the form of a lump sum, health insurance extensions, or outplacement services) give impacted employees time and resources to secure a new job. It also helps the former employer maintain positive relationships with the workforce and the broader community.

If you're offboarding employees, you can do it with the same HR suite with which you've onboarded them. Try TalentHR for free and see how you can manage the complete employee lifecycle →

Severance Pay FAQs

Q: Is severance pay mandatory?

A: Not usually. In many countries like the U.S., employers aren’t legally required to provide severance pay unless it’s promised in an employment contract, a collective agreement, or company policy. Requirements vary by region. For example, severance pay is mandatory (with certain conditions) in Ontario, Canada, or in France.

Q: How much severance pay should an employee get?

A: A common approach is 1–4 weeks of pay for each year of service, but the amount depends on tenure, role, and company policy. Severance packages vary widely, so some teams use a severance pay calculator to estimate ranges.

A: How is severance pay taxed?

A: Severance pay is typically taxed as regular income. Employers generally withhold income tax and social security contributions, so the final amount a former employee receives may be lower than the full severance payment.