Calculating severance pay can be a difficult task. When an HR team needs to calculate this, it is usually because they are putting together severance agreements for an ongoing reduction event at their organization.
Whether that event be a voluntary layoff, a furlough, or a permanent reduction in force, it is almost certain that your HR team is feeling a certain level of stress because of the impact they are about to have on your employee’s lives.
With all of this stress, it can be easy to make a mistake when calculating severance pay. There are so many things to consider, which means there are a lot of areas where you can go wrong when calculating it.
Don’t worry! We have you covered. In this blog, we will go over all of the different considerations for calculating severance pay, as well as provide you an excel template to help you start making those calculations in no time.
How To Calculate Severance Pay: Areas To Consider
There are three areas you should consider when thinking about severance pay:
- Payment based on years of service
- Vacation time
Let’s talk about payment based on years of service first.
Payment Based on Years of Service
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 is conducting some restructuring to become more efficient in your strategy, which results in only a few employees getting laid off, it makes more sense to be generous. But if your organization is having a mass layoff 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.
If your organization offers vacation and sick days to your employees, it is customary to pay out the value of that time to your employees as a part of their severance pay.
For example, if your organization gives 14 days a year of PTO and an employee has only used 6 at the time of they layoff, your organization would need to pay him or her for the 8 days they didn’t use.
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.
To calculate the amount of vacation compensation severance your employees should be getting, you will need to multiply the number of days times their daily pay rate.
To do this, divide their salary by the number of working days in a year:
And then multiply this number by the number of PTO days the employee has:
$230 * 25 days= $5,750
What about sales teams that work off of a commission payment structure? How are organizations supposed to handle those employees?
This is a common question and one that is a bit more difficult to answer. When it comes to commission-based employees, you have a few options.
The first is to simply not offer severance to 1099'd workers, opting to instead have a policy that only offers severance to full-timers. This isn't always the best way to go, though, but it is an option.
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 the severance agreement.
"Use the salesperson's annual pay from the previous year to determine an average weekly or monthly earning. Add up all earnings for the year and divide the figure by 12. If your severance package provides a 90-day payout, provide the salesperson with three months of pay based on his average annual earnings," reports Linda Ray from Bizfluent.
You can also base the payment on the sale person's best performing months, which allows you to show that you want to pay them when they are at their best and do not want to only look at the average results of their work. Ray also says that you can pay based on the average salaries of sales teams in the US who sell similar products. You are likely able to find what these rates are then divide them by 12 to get a monthly estimate.
Whatever you choose to do will largely depend on your organization and how your corporate culture operates.
Want to learn more about severance pay? Check out our calculator here: