What is severance pay? And, how is it different from redundancy pay? While it might not be the happiest subject to cover, it is key for operational effectiveness and learning how to manage it as part of your company’s HR function.
So, let’s dive into it. In this article, we will cover some basic definitions, differences, and some of the laws that surround severance pay packages, termination pay, and layoff packages in general.
What Is Severance Pay?
How Does it Differ to Redundancy Pay?
What Does the UK Law Say About Severance Pay?
I’m Confused. As an Employer Do I Have to Pay Severance Pay?
4 Examples of When Severance Pay Might Be Appropriate
What Must HR Leaders Know about Severance Pay?
What Is Severance Pay?
Severance pay, as part of a severance package, is offered to an employee, by their employer, at the end of their employment. It may also include some additional benefits, like health insurance, to help an employee secure a new role in the near future.
In many cases, a severance package or a layoff package may be used as an alternative to a redundancy package. It usually includes:
- Statutory redundancy pay
- Payment in lieu of notice
But, severance pay can be augmented with things like
- Pension payments
- Stocks or shares
- Additional bonuses
- Other discretionary amounts
Is Severance Pay Legal?
In UK law, ‘severance’ is not a legal word. Employers typically give it the same meaning as redundancy, but it is used in a different – but crucial – way. While there are many governmental and legal obligations that employers must follow in the UK if they make one or more employees redundant (our helpful article on redundancy pay provides more detail on this), severance pay is a bit more ‘fast and loose’ with the rules.
The legal firm Thomson Snell & Passmore says, “A severance package offer is usually made with the condition that employees enter into a settlement agreement which will require them to give up all their legal rights to pursue their employer for a claim or claims in an employment tribunal, including any claim for contractual entitlement to bonus, shares, commission, accrued holiday, and unlawful deduction of wages”.
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How Does Severance Pay Differ To Redundancy Pay?
Let’s break it down. If redundancy is legislated (and it is), does the same apply to severance pay? Yes, and no. Think of redundancy pay as being the basic amount that an employee must be paid when they are made redundant. A severance pay package is bigger than this.
In addition to that, severance pay is usually agreed privately and confidentially between an employer and the outgoing employee and it is made to compensate them for the loss of additional benefits. This often includes bonus and commission payments, shares, and options and sometimes even holiday pay, benefits, and notice periods.
What Does the UK Law Say About Severance Pay?
According to worksmart.org.uk (a job advice app backed by the Trades Union Congress (TUC) and Britain’s trade unions), severance pay is not a precise legal term in the UK. While the term is in common use in the USA, its use in the UK is often quite ambiguous. Normally, it refers to a payment made to an employee by an employer in return for them agreeing to leave without pursuing a claim against the business.
When a voluntary severance package is offered, employees are expected to sign a voluntary severance agreement. This protects employers, to a large extent, from claims of unfair dismissal as employment tribunals are unlikely to accept that employees were dismissed if they signed the agreement.
Do Employers Always Have To Pay Severance Pay?
The short answer to this is ‘no, not usually’. A severance pay package is usually negotiated with employees who earn a lot of money, have a lot of benefits, or who the company wants to usher out of the business as quietly as possible. If in doubt, though, refer to the legislation around redundancy pay and stick to those rules instead.
Four Severance Pay Examples To Consider
One example of when severance pay might be used is when the business would prefer not to go through a lengthy, formal grievance or disciplinary procedure to get an employee to leave.
A severance pay package might be offered to a salesperson, for instance, who has not performed to the required level. However, if it is hard to obtain documentation to confirm this, or if the employer and employee disagree about what ‘the required level’ might be, the business and the employee might agree to negotiate a layoff package or severance package that satisfies both parties.
Severance packages might also be offered to senior leaders when the business makes management changes and they ask an employee to leave, but the business would prefer not to go through formal redundancy procedures.
In cases like this, government-legislated redundancy pay would not be sufficient to cover the salary and benefits that a senior employee will lose, so the company issues a layoff package to cover the amount of their loss of work for an extended period of time.
Considering that senior staff typically have a much longer notice period (between three and 12 months), a severance pay package may pay them out in part or in full for the salary, bonus, leave and benefits they would receive during all or part of that notice period.
Severance pay packages are also sometimes issued when employees leave but have a lot of insider knowledge that could be valuable to a competitor.
A severance pay package may be issued to cover a certain number of months of them not working, on the assumption (and this can also be written into the severance pay agreement) that they will not work for a competitor during this time.
Severance pay is also issued by some companies if they want to be more generous to the employees they make redundant, perhaps because of their length of service, or because the business would prefer to ease their departure as much as possible.
Are You Documenting Severance Pay Effectively?
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What Should HR Leaders Know about Severance Pay?
Worksmart says that when employees accept an offer of voluntary redundancy which requires them to leave work immediately, employers must ensure they are paid out for their notice pay and their severance/redundancy payment.
Employees must also be paid for any holiday that they have earned but not taken by their leaving date. When making severance payments don’t forget that tax and national insurance must be deducted from all notice pay and payments in lieu of notice.
It’s also wise to ensure that employees sign a voluntary severance agreement before they are paid out. You may also want to include a confidentiality clause in the severance agreement so that the terms of the severance package are not shared with other parties.
Severance Pay Made Simple
In conclusion, while an employee’s departure from the business can be stressful for everyone involved, a generous severance pay package can help both parties. It can help employers feel that they have been as fair as possible and help employees be more financially secure as they move on to whatever activity they choose to embark on next.
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