Offering a fair severance pay is crucial to fostering trust and loyalty among employees. This package not only represents financial security but also indicates your company’s attitude towards its staff. Without severance pay, employees may feel undervalued, which can lead to poor morale and lower productivity within the remaining team.
Studies even show inadequate severance pay can increase turnover rates by up to 17%.
But managing employee severance can be challenging for international companies. HR decision-makers have to consider intricate laws and regulations, tax implications, and cultural attitudes toward pay. If any aspect of a severance package violates a rule or agreement, the company could face penalties or legal action.
Read on to understand the importance of severance pay, the common issues involved, and how to address them.
What is severance pay?
Severance pay is the compensation you award employees as they leave your organization. It acts as a financial cushion while they search for new job opportunities.
Companies normally provide severance pay during restructuring, when staff aren’t at fault for their termination. Some common examples are layoffs, downsizing, and mergers. However, businesses may offer similar packages following employee resignations and dismissals.
Although severance pay is a common practice, it’s not mandatory in every country. For example, it’s not required by US federal law—the Fair Labor Standards Act (FLSA) says employers can dictate their own terms.
Key components of severance packages
Severance packages vary widely between organizations. The exact payment and benefits often depend on the business size, industry, region, and compensation structure. For example, if employees have high base salaries, they’re more likely to receive a large amount of severance pay.
Severance packages may include the following:
- A severance payment: Alongside their final paycheck, workers usually receive extra compensation as either a lump sum or monthly installments
- A temporary continuation of benefits: Former employers may offer to continue providing health insurance and workers’ comp for a period of time
- Any accrued vacation time and sick leave: If an employee has any unused holiday pay, companies can pay them for those days or weeks
- Assistance with the job search: Managers can support employees during the severance period by offering recommendations, flexible work hours, and resources to help them find new job opportunities
- Support applying for unemployment benefits: Depending on the country, you may need to notify the government about a termination of employment. Making this a priority ensures former employees receive benefits and agency assistance as soon as possible
- Outplacement programs: Organizations can offer specialized training to departing employees to help with their job search
- Release of claims: Some employers require employees to sign an agreement stating that they will not take legal action against the organization in order to receive their severance package
It’s worth exploring your team’s insurance needs before you develop a severance package. For instance, those under the Consolidated Omnibus Budget Reconciliation Act (COBRA) have to take over payments when their work contract ends. You could alleviate some of the stress of finding a new job by continuing to pay the insurance premium for a few months.
Providing an efficient, compliant global payroll system for your team is what Deel does best.
How to calculate severance pay
In addition to determining the content of a severance agreement, you must also calculate the precise amount of severance pay owed to an employee. Here are some of the methods you can use:
- Flat rate: Offer staff the same amount regardless of their tenure, position, or location
- Salary-based: Determine payments based on each employee's standard salary. For instance, upon termination, all employees are entitled to receive a severance package equivalent to three months of their regular pay
- Tenure-based: Calculate severance pay according to the number of years an employee has worked for the company
- Position-based: Adjust severance pay based on the employee's role. As team members advance through promotions, their severance payments will increase accordingly
- Mixed: Combine methods to calculate pay based on two or three of the categories above
Using these methods can also allow you to calculate the employee benefits you should include in the package. For example, you can base the length of the benefits continuation on how many years an employee has worked for your company.
Many companies use a mix of methods to tailor severance packages to team members. Taking these extra steps makes it easier to reward specific employees for their contributions and justify varying packages.
In many cases, you could rely on each region’s legal minimum requirement. However, this amount differs between countries, which could mean international teams with similar roles and experience receive different payouts. To ensure fair and consistent treatment, consider using the same method to calculate each employee’s severance pay.
Severance pay vs. other employee benefits
Employers typically include severance pay in a contract, just like any other benefit. You can use severance packages to attract candidates to the role and offer them extra financial security.
Like bonuses, severance pay can be contingent on tenure, position, or performance and is subject to taxes. US companies can withhold severance pay taxes the same as they would with supplementary pay—they can either maintain the previous tax rate from the employee’s paycheck, or apply a fixed rate of 22%.
However, there are some distinctions between severance pay and similar packages like pensions and 401(k) plans. It’s important to clarify with employees that the package is a temporary measure, not a long-term benefit, even if payments and benefits continue for a few months.
Also, differentiate between your severance and termination packages. Given the stigma that comes with losing work, departing employees are likely to feel stressed, anxious, and depressed. You can alleviate some negative emotions by clarifying what benefits former employees are entitled to and why.
Share this information in employment contracts and answer common FAQs about severance in your employee handbook. Encourage staff to read through the handbook for a more in-depth understanding of your policies and the relevant laws.
Why severance pay matters
Legal considerations often top the list of reasons why companies offer severance pay. If you violate labor laws, you can face high penalties or even legal action as X (formerly known as Twitter) did with their recent $500 million lawsuit.
Even when severance pay isn’t mandatory, offering this compensation is still common practice. It has advantages that extend beyond staying compliant with labor laws and avoiding penalties. Here are some ways severance pay can impact your organization:
- Smooth transitions: Severance pay incentivizes workers to help companies manage the handover process and transfer all their relevant knowledge and skills to the remaining staff. By cooperating, employees are also more likely to take full advantage of all the benefits and assistance you can provide
- Positive relationships: Within certain industries, businesses may continue to work closely alongside former employees or depend on them for references. Offering severance and handling terminations with grace ensures you’ll maintain strong relationships moving forward
- Improved morale: Studies show 63% of employees experience anxiety after their team members get laid off. You can alleviate their concerns and bolster morale with the promise of financial assistance if they lose their positions
- Higher recruitment rates: As you include severance packages in new employment contracts, you could use this benefit to attract more candidates to open roles
- Lower turnover: Employees are 7.7% more likely to quit after layoffs at their company. Severance pay may convince them staying with you is the more secure option during turbulent economic times
- Reduced expenses: The true cost of an employee is more than their salary—it also includes hiring, training, and productivity. If paying severance minimizes issues like turnover and demotivation, you’ll save money long-term
- Reputation management: Offering severance pay shows employees and customers that you’re an ethical, forward-thinking enterprise
Hire anywhere without worrying about local laws, complex tax systems, or managing international payroll. Focus on finding the perfect match for your team, we’ll take care of the rest.
Global perspectives on severance pay
While severance pay has many advantages, global teams may find it challenging to implement. They have to develop packages that are compliant with international laws while maintaining fair and consistent policies across all their teams.
HR teams have to navigate the intricate labor laws for each country. For example, the UK government has a complex, tiered system where employee’s severance pay is based on their age and years of service. If they moved into a different age bracket during their contract, you have to apply different rates.
When countries base termination pay on length of service, finance departments also have to account for severance pay accrual. Otherwise, they may receive a high final invoice after releasing long-term employees from their contracts.Managing compliance becomes increasingly complex if you relocate employees or add more nationalities to your team. In some cases, your workers, their country of residence, and the company headquarters are in different jurisdictions—meaning you have to consider three different legal systems.
To make compliance simpler, entities like the Organization for Economic Cooperation and Development (OECD) and the International Labor Organization (ILO) have introduced guidelines for fair practice. They provide references for severance packages that you can refer to when developing your own.
Using a global HR provider like Deel also gives you access to expert legal advice on international severance requirements. Our team of professionals works with you to create employment contracts that meet legal and contractual obligations. As we operate in over 100 countries, you can hire or relocate employees wherever you need to without worrying about labor law violations.
When you have to release employees, your HR provider ensures you meet the terms of the contract. Outsourcing this administrative work means your HR teams can focus on supporting workers during this typically stressful period.
A global provider like Deel also means faster, more flexible payroll. You can manage severance payments for employees in different countries without the added stress of currency conversions or long transfer times.
Trust Deel with your offboarding process
Navigating the complexities of severance agreements is essential, especially when managing a global team. You not only have to stay compliant with all relevant employment laws but also protect former employees and reassure your remaining workers.
Deel can support you throughout onboarding and offboarding. We help you prepare contracts that meet legal and contractual obligations and minimize risks to your organization. With our automation and document management features, you can also reduce administrative work so HR teams can prioritize supporting employees.
Learn more about Deel’s offboarding features and book a 30-minute demo with one of our product experts.
Disclaimer: This content is provided for informational purposes only and should not be considered legal or tax advice. Please consult with professionals for guidance before taking any action.
