If your organization is planning a layoff in the coming months, you are probably currently researching how to create a severance pay policy and best practices around severance policies.
Which you should be!
Layoffs are always stressful, and severance agreements can have a major impact on the success of your company wide reduction. Your organization’s dedication to developing a strong severance pay policy and implementing best practices will be more beneficial in the long run than any other area of your layoff’s management.
Before we get started explaining what you should include in your severance pay policy, make sure to download our sample with the button below:
Okay, now let’s get started…
What Should You Include in a Severance Pay Policy?
Your severance pay policy should be hosted in a public place so that all of your employees have access to it. This could be your employee handbook or your company wide intranet.
The purpose of this is to be as transparent as possible surrounding your policy so that in the event of a reduction event your employees aren’t surprised. Which will in turn help to lower the chances of any lawsuits against your organization.
So, what things should you include in your severance pay policy?
Here are the most important parts for your policy to cover:
- Who is Eligible
- Qualifying events
- Payment Amount
- Insurance Benefits
Let's start from the top:
Who Is Eligible?
In this part of your severance pay policy you will what to include which of your employees this policy will apply to, and in what ways they will be affected by the policy.
Make sure that you explain this in detail to rule out any confusion from your employees. The following categories are usually labeled as either eligible or ineligible in this section:
- Full Time Employees
- Part Time Employees
- Exempt Employees
- Non-exempt Employees
- Contract Workers
And on and on. Your organization might choose to prorate your part time employees eligibility based on the amount of hours they have worked over a certain tenure. Make sure to include this in this particular section as well.
This part of your severance pay policy will specify which types of events this policy pertains to. It is also extremely important in this section to provide details so that your employees do not expect a certain amount of severance pay for a situation that doesn’t qualify.
For example, if you didn’t provide any details about what types of events qualify, an employee who was terminated for poor performance might be able to prove that they were owed a certain amount of severance based on this policy.
Another thing to consider is that different types of reduction events might require different severance pay policies.
Voluntary layoffs typically have higher severance payouts to incentivize people to volunteer for the reduction. If your organization has different types of reduction events that have a wide range of payouts, it would make sense to create different policies for each specific situation.
Here are some common qualifying events for your organization to consider including in this section:
- Reduction in Force
- Shift in Company Strategy
- Position Elimination
Some organizations also include types of events that wouldn’t qualify an employee to receive this severance pay. For example, this means if an employee refuses a new assignment or to relocate (within a reasonable distance), that it is not a qualifying event.
Before we get started, it is important to mention that this blog doesn’t take into account the various federal or state laws you may need to comply with based on your organization’s demographics. It is important to consult with your corporate counsel or attorney before executing any sort of RIF or reduction event, including crafting a severance agreement, to ensure you are fully compliant with these laws and the requirements set forth by the EEOC to protect workers.
With that out of the way, let's get into it.
Most organizations calculate severance pay based on how long an employee has been with the organization. Different industries have different standards of pay for the length of service.
And depending on your organization’s financial situation, you might need to give less pay than the industry standard.
But for all intents and purposes, here is an example:
Calculating Severance Pay Based on Tenure
Length of Service
The severance payout table listed above is a very generous example. You could expect this type of severance payout scheme from an organization that has a very heavy focus on employee value proposition, such as Google.
Depending on your industry, it could be more common to see a severance payout scheme that looks more like this:
Calculating Severance Pay Based On Tenure #2
Length of Service
It all depends on your industry's common practices and the financial situation of your organization.
If your organization regularly conducts restructuring to become more efficient with your strategy, which results in only a few employees regularly getting laid off, it makes more sense to be generous. But if your organization continually has mass layoffs because of financial downturn, you will want to reconsider the payout in regards to your bottom line.
When considering the payout scheme, it is also important to think about the tenure of your workforce, and then adjust accordingly based on industry best practices and your organization’s bottom line as well.
Whichever type of payout scheme you create, it is important to not continuously switch your severance pay policy before and after events. It will upset your employees because they will feel that you have cheated them out of severance pay they deserved for their tenure at your organization. Which will result in legal action against your organization on their part.
Because of this, if you plan on switching your policy, make sure that you do so transparently. Send out a company wide memo, and try not to make big changes to the policy in the months leading up to a reduction event.
You can read more about this in our blog about how to calculate severance pay and you can click the button below to download our severance pay calculator.
Your severance pay policy should also include how your organization will handle the payout of any banked vacation days that your laid off employees have.
This can get tricky if your organization uses an accrual system. In some industries, such as healthcare, it can be common for employees to have a huge amount of vacation time built up. That is why several organizations have policies in place that say in the event of a layoff they are only required to payout up to a certain amount of vacation time.
For example, if Lisa, a nurse at your hospital, has accrued 42 days worth of vacation time at the time of her layoff, but your company has a policy in place that states they will only payout 25 vacation days, you organization would only have to compensate for those 25 days.
It is important that your organization institutes these policies in advance and communicates them to employees to avoid any legal troubles. Once you institute this policy, make sure to include it in an employee handbook and go over it during your onboarding process for new employees.
It is also important that your organization details how any commission will be paid out in the event of a reduction event.
Most organizations will pay out any commissions leading up to the laid off employees last day at the organization. This is a pretty common practice.
Where this gets tricky is estimating the payout scheme of an employee based on their tenure at the organization.
Let’s take for example Sarah, a salesperson at your organization, Jayhawk Lockers. She has been with your organization for eight years, so according to the payout scheme listed in your severance pay policy, she should receive eight weeks of severance pay.
But what if Sarah’s pay has been purely commission? How do you know how much pay constitutes 6 weeks worth?
Typically, the easiest way to calculate severance pay for commission-based workers is to get an average pay rate during their tenure at your organization and then pay them based on that average using a chart similar to the ones above. This allows you to fairly balance how much pay they get with the added benefit of it being easy to explain in your severance pay policy.
Severance Policy Best Practices
It is important for your organization to develop a severance pay policy in accordance with best practices to mitigate any potential litigation.
Here are some best practices your human resources team should consider when developing your policy:
- Create a policy that treats all members of your organization fairly. Run a risk analysis of your policy to see if any groups of employees are negatively impacted, and then redraft your policy to lessen the impact.
- The most important severance policy best practice is to create a culture of transparency around the information. Whenever you make changes to the policy, send out a memo to your organization.
- Speaking of transparency, keep the policy in a centralized location available to your employees. Require them to read it in your employee handbook, host it on your company intranet, or keep it in a facilities area where they have access to it.
- Have a written policy! You are already have a great start on drafting one by reading this blog.
- Benchmark your severance pay policy against others in your industry and geographical location to make sure that you are in alignment with your employee value proposition.