Severance pay refers to financial compensation, often with extended benefits, that employers provide when parting ways with staff. This pay helps bridge financial gaps as departing employees search for new positions.
What you’ll learn
What you’ll learn
Updated: July 9, 2025
Key takeaways
- Severance packages offer financial stability to departing employees.
- Packages can extend beyond monetary pay and include extended health insurance and other benefits.
- Assessing and adhering to existing labor laws is crucial when designing a severance package.
This guide covers what severance packages typically include, legal and financial considerations to keep in mind, and best practices for introducing these programs.
What is a severance package?
Simply put, a severance package provides financial compensation and, oftentimes, extended benefits to support departing employees. The compensation is usually based on length of service and can include extended health insurance and retirement benefits. Each organization structures these packages differently, and there’s no federal law that requires these arrangements.
Purpose of severance packages
As described below, severance packages serve multiple purposes that can benefit both the employers providing the payouts and the departing employees receiving the compensation.
Providing financial security for employees
The primary objective of a severance agreement is to provide financial stability/relief to an employee who has been terminated. Job transitions can take months, and the loss of income can be financially and emotionally devastating for most people. A severance package can alleviate the financial strain and anxiety and provide some support as one endeavors to replace his or her source of income.
Enhancing employer reputation
In many cases, offering a comprehensive severance package can enhance an employer’s image. It demonstrates a company’s commitment to the fair treatment of workers, and it can enhance recruitment efforts, especially in competitive job markets.
Reducing legal risks
As noted previously, there is no federal law requiring employers to offer severance packages, but those that do can safeguard against legal disputes. Companies that stick to labor laws regarding severance face fewer legal challenges with terminations. Transparent policies create clear frameworks that eliminate ambiguity and reduce misunderstandings and conflicts.
By strategically implementing severance agreements, companies can prevent civil lawsuits from disgruntled employees. Most agreements include waivers that prevent employees from taking legal action for certain claims, effectively preventing retaliatory lawsuits following layoffs.
While severance packages can reduce legal risks, employers offering them must still obey labor laws. Severance packages cannot infringe on employees’ rights, and employers have an obligation to stay on top of statutes regarding severance and termination.
While the federal government doesn’t have laws requiring severance, some states have final paycheck laws. Check out our state-by-state final paycheck laws breakdown for more information.
Components of severance packages
Generally, a severance package includes up to five distinct features. Each is described below.
1. Monetary severance pay
Severance pay, or dismissal pay, is the backbone of any severance package. The amount of the payout usually depends on the duration of employment, with many employers offering one or two weeks of severance pay for every year spent at the company. However, this varies between businesses and industries.
A company may adopt a unique formula for calculating severance based on the market’s competitiveness. In certain industries, such as finance, healthcare, and technology, severance is seen as an issue of corporate responsibility and may involve high amounts.
2. Health insurance continuation
Most employers offer health insurance options as part of severance packages, and many negotiate terms based on individual needs. As with severance pay, health insurance continuation isn’t mandatory, but many employers opt to offer the extension of benefits to help facilitate job transitions.
For businesses with 20 or more employees, the Consolidated Omnibus Budget Reconciliation Act (COBRA) requires that sponsored group health plans offer continuation health coverage for a limited period. However, employers are not required to bear the cost of the continued coverage. To learn more, see the U.S. Department of Labor’s Continuation of Health Coverage page.
3. Retirement benefits
Employers have several options for incorporating retirement benefits into severance packages. For example, if an employee is close to meeting vesting requirements for their retirement plan, the package might include an agreement to accelerate vesting, entitling an employee to full benefits.
Additionally, a severance package usually includes information on how departing employees can manage their vested retirement funds. The information might include instructions on rolling over a 401(k) balance into an IRA or options for pension plans, if applicable.
4. Career transition services
Career transition services are designed to help departing employees navigate the job market and improve their ability to land a new job. Specific services include career coaching, resume writing, and interview prep.
Offering career transition services is a thoughtful way of handling employee terminations. It can boost an employer’s reputation and aid in the job placement of former employees. Research shows that career transition services can increase the odds of someone finding suitable employment by 2.67 times. Several studies also suggest that people find work faster using these types of services.
5. Non-compete and non-disclosure clauses
The fifth feature found in many severance packages is actually designed to benefit employers. We’re talking about non-compete and non-disclosure agreements.
A non-compete clause restricts departing employees from working for a competitor or starting a competing business for a specified period and within a defined geographical area. It prevents a departing employee from using the skills, knowledge, and relationships gained while employed against his or her former employer.
In 2024, the Federal Trade Commission (FTC) enacted a rule to ban most non-compete clauses. While the exact ramifications of this rule are still being decided in courts, businesses should be aware that there may be legal limits on these clauses.
A non-disclosure clause offers similar protections, but focuses on proprietary or confidential information. It restricts the sharing or using of company information or intellectual property for personal gain or to inflict harm, thereby protecting a business’s competitive advantages. Protected information under such a clause potentially includes client lists, business strategies, product formulas, software code, financial data, and other proprietary data.
Severance pay vs. separation pay
People often use the terms “severance pay” and “separation pay” interchangeably, but they have distinct meanings. Severance payments follow employee terminations, severing the employment relationship. Separation pay, on the other hand, is a broader term; it includes all payments an employee is entitled to upon separating from the company, regardless of the reason for leaving (i.e., voluntary resignation, retirement, etc.).
To reiterate, severance pay is offered as a financial cushion following termination, whereas separation pay is a settlement of all outstanding financial obligations, including unused vacation time, sick leave, and expense reimbursements.
Legal considerations in severance packages
Typical severance packages require careful consideration of existing laws to ensure compliance. For example, while non-compete and non-disclosure agreements are common, there are specific non-waivable employee rights, like the right to file a charge with the Equal Employment Opportunity Commission.
Also, to be legally enforceable, waivers must be knowing and voluntary. Employers should review labor laws and pertinent state laws regarding termination and final paychecks to ensure they are compliant.
Best practices for offering severance packages
Any business offering a severance package to employees should strive to adopt best practices to optimize administration and ensure compliance with labor laws. The top two guiding principles are as follows:
- Customize packages to address individual circumstances.
- Communicate package specifics to employees, including details regarding eligibility and payout parameters.
- Leverage HR software to manage your severance package policy.
Embracing these principles can improve your employment relationships and preserve your company’s reputation.
Creating a severance package should be on your to-do list
While employers are not legally required to offer severance packages, doing so can be beneficial for a variety of reasons, including supporting workers, strengthening your employer brand, and enhancing recruitment efforts. Having a clear severance policy demonstrates responsibility to current and future employees — and helps soften the landing for departing employees. And if you’re looking to streamline your human resources operations and find more efficient ways to pay your employees, learn more about how OnPay’s HR and payroll software can help you take care of your team.
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.