Designing and Administering Severance Pay Plans

Administering Severance Pay Plans

A severance pay retiring allowance is money paid to a departing employee at the end of an employment relationship. The amount may vary depending on the length of tenure with a company, circumstances surrounding termination, and business needs. Companies that choose to offer severance pay should clearly articulate a policy that defines the amounts and conditions for the benefit.

Employers should also be prepared to administer the severance pay plan on an ongoing basis, ensuring that payroll and benefits departments are following through with the terms of the arrangement. By allowing departing employees to receive their full severance payment, employers demonstrate that they care about their employees even after they leave the company.

severance pay is often a component of a larger package of termination-related benefits that may include continued health insurance coverage, reimbursement of outplacement expenses, or other perks such as the option to keep a company cell phone. These perks can have a big impact on an employee’s financial situation after termination, so it is important for an employer to weigh the pros and cons of these unique policies.

Designing and Administering Severance Pay Plans

Some severance pay plans may be considered to be an “employee benefit plan” under the Employee retiring allowance Income Security Act of 1974, as amended (ERISA), and therefore subject to the reporting and fiduciary requirements under that law. Others, however, are not. Whether a severance pay plan is subject to ERISA depends on a number of factors, including the structure of the plan, whether it provides for a vesting schedule, and the amount of money that will be provided to an employee upon leaving the company.

Many severance pay policies are not subject to ERISA, and are instead treated as a form of wages. In these situations, the federal tax rules that apply to wage payments are generally the same as those that apply to other types of wages. Consequently, the same rules for withholding applicable to ordinary paychecks will apply to severance pay, such as federal income tax withholding based on the employee’s completed W-4 and Social Security and Medicare taxes.

For some severance pay plans, the amount that is paid to departing employees is calculated on a formula such as one week of pay for each year of service up to and including 10 years. Other severance pay plans may be calculated using a flat rate per year of service or on an annual bonus amount that is paid out at the end of each performance period.

In some cases, severance pay is also tied to an employee’s eligibility for an early retirement incentive program. Such programs are permitted, but they must be designed to prevent age discrimination. In addition, such programs must be voluntary, and the employer cannot impose an early retirement incentive on any employee who does not volunteer to participate in it. In order to avoid such claims, it is recommended that employers consider consulting with a benefits attorney before creating a new policy.