Severance Pay

Severance Pay Meaning

Severance pay is that pay which is paid to employees who are removed or terminated from the employment of the company. It  is generally paid to the employees who  are being let go from the job due to the reasons of job elimination or downsizing, rather than the reasons for voluntary termination of job on the part of the employees.

Explanation

  • The severance is not mandatory. It has some rules to be followed.
  • If an organization has more than 100 employees, then according to W.A.R.N. Act (Workers Adjustments & Training Notification Act), the organization is planning for a lay off then the employer needs to give a legal notice of 60 days to leave the organization. And on failure to give such notice, the organization then would have to legally pay the Severance pay to all the employees the company is planning to lay them off without the prior notice to them.
  • Also, it is at the discretion of the management of the company to pay to the employees in case if the company is on budget cuts, restructuring, etc., and not due to poor performances.
Severance-Pay

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For eg:
Source: Severance Pay (wallstreetmojo.com)

Why Are Companies Providing?

Severance is a kind of courtesy to the employees as it helps the employees much required time to find a new job with the least of salary paid without being on the job. That is the employees who are terminated not because of low performance, but because of budget cuts or laying off, providing them with this pay helps them find a new job with an advance salary. It is also related to the goodwill of the company unless the employer is obligated to pay to the employees by way of the employment agreement or elsewhere in the rules of the employers.

Example

Let us say the Apple Inc. of USA has a policy of paying their employees with the Severance pay when they are being laid off, or their job is terminated due to a reason other than the performances or misconduct.

The pay is decided by the management based on the salary of the employee being terminated and the no. of days are also decided by the management to help employees cope up with the financial help for a little period they would be unemployed and get time to find a new job or an alternate source of finance.

Severance Pay vs. Termination Pay

Severance pay and termination pay are both different from each other but generally termed as same in the practical industry. But they are two different kinds of remunerations to be paid to employees. Some of the key differences are explained below:

  1. Severance pay is not mandatory for any employer to pay, whereas termination pay is mandatory to be paid on termination. There is no designated formula to calculate this pay. Also, it is at the discretion of the employer whether or not to pay and how much to pay. In contrast, Termination pay is calculated based on the no. of days notice a period employee has served before leaving the job, and it is mandatory to pay for the employer.
  2. Severance is not the right of the employees as there is no backing of such payment unless it is in the employment contract or agreement, whereas termination pay is the right of the employees if the employee has completed his notice period before leaving the job.
  3. Both severance pay and termination pay helps employees financially, but receiving severance pay from the employer will help to build the goodwill of the company as this is one kind of extra benefit which the company would offer to its employees over and above the termination pay.
  4. Severance pay given to employees provides employees with a little extra time to find another job or alternate source of income, whereas termination pay is that pay for which the employee has already worked for the employer.

Importance

  • Today in this competitive market, it plays an important role in creating goodwill of the company, which pays their employees the severance pay on their termination of the job from the organization due to various reasons which include layoffs, removal from the post, personal or various other reasons.
  • The employers don’t need to pay it. Still, if it is mentioned in the employee contractual agreement, then this becomes mandatory for the employer to pay the employee on leaving the employment.
  • The importance is also on the part of the employees as well. They might be susceptible to a shortage of funds when they are let go of the job. Hence, this severance can help these employees in terms of finance until they get a new job or until they get a new source of income.

Advantages

Some of the advantages are as follows:

  • Severance pay helps the organization in building its goodwill among the industry.
  • It helps employers get better employees as extra pay will motivate employees to join the company.
  • It is an added emolument for the employees, which helps employees financially after being terminated from the job.
  • Severance pay is paid at the discretion of the management. Therefore it is up to the management to pay or not to the employees.
  • It helps employees to get time to find a new job or alternate source of income with extra pay in their pockets even for a small period.
  • It plays a role in the benefit of both the employer as well as employees.

Disadvantages

Some of the disadvantages are as follows:

  • Severance is not mandatory due to which the employees may suffer financial losses when they are being terminated.
  • There is no rule or any kind of law which backs this pay to be mandatorily paid by the companies.
  • If the company goes with the payment of such payments, then it would increase the employee’s cost of the company.

Conclusion

Severance pay is pay to help employees financially for a small period after they are terminated due to the reason for budget cuts, removal from the posts, or lays off, rather than the reasons for low performance or misconduct. It is a kind gesture from the employer towards its employees to help them both financially and emotionally. Paying severance is for the benefit of the organization as well as it helps to build reputation and goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more in the industry.

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