While it might not be the most pleasant subject to cover, severance pay is something that most employees and employers will have to deal with at some point in their life. But with staff morale, business finances, and legal regulations to balance, it can be a tricky thing to get right, especially if you are a small or medium enterprise.
In this article, we will discuss what severance pay is, how it differs from redundancy pay, as well as look at some of the laws that surround severance packages.
What is Severance Pay?
Severance pay is offered to an employee by their employer when their employment comes to an end. It may include additional employee benefits, like health insurance, to help an employee secure a new role in the near future.
In many cases, a severance package may be used as an alternative to redundancy and may include any of the following benefits:
- Statutory redundancy pay.
- Pension payments.
- Payment in lieu of notice.
- Any stocks or shares the employee is entitled to.
- Any additional bonuses the employee is entitled to.
- Other amounts or benefits at the discretion of the employer.
Is Severance Pay Legal?
In UK law, ‘severance’ is not a legal word. Employers typically give it the same meaning as redundancy, but it is often used in a different way. While there are many governmental and legal obligations that employers must follow in the UK if they make their employees redundant, severance pay is a bit less rigid with the rules.
A severance package is usually made to an employee with the condition that they give up all their legal rights to pursue a claim against the employer in an employment tribunal.
Are Severance Pay and Redundancy Pay the Same Thing?
As mentioned above, redundancy and severance pay are similar, but there are a few key differences. Severance pay is compensation an employee receives when their employment is terminated early. Redundancy pay and other entitlements may be included in the severance pay. Severance pay is usually offered when an employee retires, is laid off, or when a position is eliminated.
Redundancy pay is owed when an employee has been made redundant because their job is not required by a business anymore. Redundancy pay is a form of severance pay but is only given in this limited set of circumstance.
Some examples of why redundancy occurs is when new technology is introduced, the business closes or relocates, there is a restructuring of the firm, or the profits of the business have decreased.
What Does UK Law Say About Severance Pay?
The use of severance pay in the United Kingdom is often quite ambiguous. Normally, it refers to a payment made to an employee by an employer in return for them agreeing to leave without pursuing a claim against the business.
When a voluntary severance package is offered, employees are expected to sign a severance agreement. This protects employers from claims of unfair dismissal. The informal nature of severance pay means that it is not covered by UK law.
If redundancy pay is to be included in the severance package, this is governed by the Employment Rights Act 1996 and the regulations set out within this must be followed. According to the law, an employee is entitled to redundancy pay on dismissal when:
- Their position no longer exists within the company (due to restructuring or downsizing, for example).
- Their role is no longer required at their place of work (due to outsourcing or relocation of operations, for example).
- The duties undertaken by an employee are no longer required by the company (due to changes in business needs).
Do Employers Always Have to Pay Severance Pay?
No, not usually. A severance pay package is usually negotiated with employees who earn a lot of money, have a lot of benefits, or who the company wants to push out of the business as quietly as possible.
As an Employer, Should I Have a Severance Pay Policy?
As an employer, you should have a clear policy in place for how severance pay is managed. As there are no legal requirements, your severance policy will depend on your own employment contract. It should, however, clearly outline your employee’s rights.
Your severance pay policy should include:
- A list of which employees are eligible for severance packages.
- A list of what the parameters and requirements are for receiving severance pay.
- A breakdown of which benefits and payments you will include in severance packages.
- A statement of how many weeks’ paid notice employees will receive according to the length of service.
If you decide to offer employees severance pay, you need to make sure that any severance policy details how you intend to get them to sign a voluntary severance agreement. This will protect you from claims of unfair dismissal. You might also want to consider including a confidentiality clause in your severance agreement template to prevent disclosure of the terms of the severance package.
Do I Have to Pay Tax and National Insurance on Severance Pay?
This depends on what benefits are included in your severance package. What you pay tax and National Insurance on depends on what’s included in your termination payment.
Some parts of your termination payment may be considered earnings, meaning they are subject to tax and National Insurance.
In general, you’ll pay tax and National Insurance on:
- Unpaid wages
- Holiday pay
- Bonus payment
- Payments for agreeing to enter a restrictive covenant
- Any payments received instead of working a notice period – this may be payment in lieu of notice or part of any severance pay
While an employee’s departure from a business can be stressful for everyone involved, a generous severance pay package can help both parties. It can help employers feel that they have been as fair as possible and help employees be more financially secure as they move on to whatever activity they choose to embark on next.