What Is a Severance Package?
A severance package is a set of benefits and compensation provided to an employee upon termination of their employment. Severance is not required by federal law, but it is a common feature of employment agreements — particularly for senior roles, executive positions, and employees being terminated without cause.
Severance packages serve multiple purposes: they provide financial support to the departing employee, incentivize the employee to sign a release of claims, and help maintain goodwill during the transition.
When Severance Applies
Termination Without Cause
The most common trigger for severance is termination without cause — when the employer ends the employment for reasons unrelated to the employee's performance or conduct. Restructuring, role elimination, and strategic changes are typical without-cause scenarios.
Good Reason Resignation
Many employment agreements allow employees to resign for "good reason" and receive severance. Good reason triggers typically include material reductions in salary, significant changes in job duties, mandatory relocation, or breach of the agreement by the employer.
Change of Control
Some severance provisions are triggered by a change of control (such as a merger or acquisition) combined with the employee's termination. These "double trigger" provisions protect employees who lose their jobs as a result of a corporate transaction.
When Severance Does Not Apply
Severance is typically not provided in the following situations:
- Termination for cause (misconduct, policy violations, criminal activity)
- Voluntary resignation (without good reason)
- End of a fixed-term agreement where no renewal is offered
- Death or disability (which may trigger separate benefit provisions)
Components of a Severance Package
Cash Severance
Cash severance is the core component and is usually calculated using one of these methods:
- Fixed amount — A set number of months of base salary (e.g., 6 months of base salary)
- Formula-based — Based on length of service (e.g., 2 weeks of base salary per year of employment, up to a cap)
- Salary continuation — Regular payroll payments continue for a defined period after termination
The appropriate amount depends on the employee's seniority, the company's norms, and the competitiveness of the offer.
When negotiating severance, consider whether payments should be made as a lump sum or through salary continuation. Salary continuation is generally preferred by employers because it can be stopped if the employee violates post-employment obligations like non-solicitation or confidentiality.
Bonus Payments
The agreement should address whether the employee receives:
- A pro-rated bonus for the year of termination
- Any earned but unpaid bonus from the prior year
- Target bonus payout as part of severance (common for executives)
Health Insurance Continuation
Most severance packages include continued health insurance coverage. Common approaches:
- COBRA premium payment — The employer pays the employee's COBRA premiums for a defined period (typically matching the severance period)
- Direct coverage continuation — The employee remains on the company's plan for the severance period
- Lump sum health stipend — A fixed amount to cover health insurance costs
Equity Treatment
The severance provision should address what happens to unvested equity:
- Continued vesting — Equity continues to vest during the severance period
- Accelerated vesting — A defined number of additional months of vesting are granted immediately
- Extended exercise period — The employee has additional time beyond the standard 90 days to exercise vested stock options
Outplacement Services
Some employers provide outplacement services — career coaching, resume assistance, and job search support — as part of the severance package. This is more common for senior roles and during large layoffs.
Reference and Announcement
The severance agreement may include terms about how the departure will be communicated internally and externally, and whether the employer will provide a neutral or positive reference.
The Release of Claims
Why Employers Require a Release
Nearly all severance packages are conditioned on the employee signing a separation agreement and general release of claims. The release prevents the employee from later suing the employer for claims arising from their employment or termination.
What the Release Covers
A comprehensive release typically covers:
- Employment discrimination claims (federal and state)
- Wrongful termination claims
- Wage and hour claims (where legally permissible)
- Contract claims
- Tort claims (defamation, emotional distress, etc.)
What Cannot Be Released
Certain rights cannot be waived in a release, including:
- Workers' compensation claims
- Unemployment insurance benefits
- Rights under COBRA
- Claims that arise after the release is signed
- In some states, certain wage claims
ADEA Considerations
For employees age 40 and older, the Age Discrimination in Employment Act (ADEA) imposes specific requirements for a valid release:
- The release must specifically reference ADEA claims
- The employee must be advised in writing to seek legal counsel
- The employee must be given at least 21 days to consider the release (45 days for group layoffs)
- The employee must have 7 days to revoke the release after signing
If your severance package requires a release of claims, make sure the release complies with the ADEA requirements for any employee age 40 or older. Failure to comply can render the release of age discrimination claims unenforceable, even if the employee signed it.
Structuring Severance by Role
Entry-Level and Mid-Level Employees
Severance for standard employees is often modest — 2 to 4 weeks of base salary, with possible COBRA premium payment for the same period. Many employers handle this through a general severance policy rather than individual employment agreements.
Senior Managers and Directors
Senior managers typically receive 3 to 6 months of base salary, pro-rated bonus consideration, and several months of COBRA coverage. Non-solicitation and confidentiality obligations are typically reinforced in the severance agreement.
Executives and C-Suite
Executive severance packages are significantly more generous and may include:
- 6 to 24 months of base salary
- Target bonus payout (or pro-rated actual bonus)
- Full or partial acceleration of unvested equity
- Extended stock option exercise periods
- 12 to 18 months of COBRA coverage
- Outplacement services
- Legal fee reimbursement for reviewing the severance agreement
Clawback Provisions
Some employers include clawback provisions that allow the company to recover severance payments if:
- The employee violates non-solicitation or confidentiality obligations
- The employee disparages the company
- It is later discovered that the employee engaged in conduct that would have constituted cause for termination
Clawback provisions incentivize compliance with post-employment obligations and protect the employer's investment in the severance package.
Tax Implications
Severance pay is generally taxable as ordinary income and subject to federal and state income tax withholding, Social Security, and Medicare taxes. For large lump-sum payments, supplemental wage withholding rates may apply.
The agreement should note that the company will withhold applicable taxes from all severance payments and that the employee is responsible for any additional tax obligations.
Best Practices
- Define severance triggers clearly — Specify which termination scenarios qualify for severance
- Condition severance on a release — Require a signed separation agreement and release of claims
- Address all compensation elements — Base salary, bonus, equity, benefits, and perks
- Include compliance with post-employment obligations as a condition of continued severance
- Follow ADEA requirements for employees age 40 and older
- Consider salary continuation over lump sum for better control and compliance incentives
- Review and update severance provisions periodically to ensure market competitiveness
A well-structured severance provision protects both the employer and the employee. It provides a clear framework for handling terminations professionally, reduces legal risk through a release of claims, and demonstrates the company's commitment to treating departing employees fairly.