Severance pay is money an employer provides to an employee when their job ends involuntarily. It is most common in cases of redundancy, reorganisation, or business closure, but can also arise from negotiated exits.
The purpose of severance is to ease the transition after job loss, provide a financial cushion, and recognise the employee’s years of service. Some countries make severance mandatory; others leave it to company policy or individual agreements.
A severance package may include not only a payment, but also health insurance continuation, payment for unused vacation time, outplacement services, or career coaching to help the person find a new job.
Globally, the rules vary. Some employers are required to pay severance by law; others choose to offer severance as a goodwill gesture or to avoid disputes. What remains consistent is that severance represents a respectful close to the employment relationship — one that protects both sides.
When employers provide severance pay
Employers provide severance pay in several circumstances. The most common reasons include:
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Layoffs or redundancies
When roles are eliminated due to structural or financial reasons. These are often referred to as reductions in force. -
Business closure or relocation
When a company shuts down or moves operations, and employees can no longer be retained. -
Unlawful or disputed dismissals
In some countries, courts may order severance where termination is found to lack proper cause or procedure. -
Mutual separations
When both parties agree to end employment, often with a negotiated payment and a written severance agreement. -
Settlement of claims
Employers may offer severance pay to avoid litigation, particularly in disputes about unfair dismissal or discrimination.
In every case, the goal is to protect employees’ financial stability and reduce risk for the employer. A well-managed severance process demonstrates fairness, consistency, and compliance — all of which help preserve company morale and reputation.
What’s included in a severance package
A severance package can vary widely between companies and jurisdictions. Its contents depend on contract terms, collective agreements, and local law. Common elements include:
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Severance pay — a one-time or lump sum payment based on years of service and average salary.
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Payment for unused vacation or paid time off (PTO) that has accrued.
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Continuation of health insurance, sometimes through a government or private scheme.
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Outplacement services and career coaching to support job searches.
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Legal agreements, such as non-disclosure agreements (NDAs), non-compete clauses, or mutual waivers of future claims.
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Notice pay or payment in lieu of notice, if the employee is released early.
Severance packages can vary not only by company size but also by role. Senior executives or long-serving employees often receive more generous terms than entry-level employees.
While details differ, the intention is universal: to treat departing employees with respect and to mitigate potential conflict or hardship.
How severance pay is calculated
There is no single global severance pay formula. Each jurisdiction determines its own standards, but most approaches follow a similar pattern: pay for each year of service, adjusted for salary level and reason for termination.
A typical formula might grant half a month to one month of pay for each year of service.
For example:
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2 years of service = 1–2 months’ pay
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5 years of service = 2.5–5 months’ pay
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10 years of service = 5–10 months’ pay
Some systems cap the total payout; others increase it for seniority or dependents. Collective agreements can add additional multipliers.
When employers calculate severance pay, they usually consider:
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Base pay and bonuses during recent months
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Unused leave balances
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Legal or contractual notice pay
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Benefits continuation costs
In countries like Germany and Poland, statutory formulas define the exact calculation. In others, like Finland or Italy, amounts may depend on court rulings or collective agreements. Employers should always document their calculations, especially where the law is open to interpretation.
Country examples of severance pay
Germany
Severance is not automatic, but if an employee is dismissed without a valid reason or proper procedure under the Dismissal Protection Act, courts often order payment. The standard reference is half a month’s pay for each year of service. Many employers offer severance packages proactively to avoid legal disputes.
Finland
Termination must be based on a “proper and weighty reason.” If not, courts can award 3–24 months of salary as compensation. Legal costs can exceed the payment itself, so Finnish employers often offer severance pay through mutual agreements to manage risk.
South Africa
When a dismissal is due to operational requirements (redundancy), it's mandatory for employees to receive severance pay. The statutory rate is one week’s pay for each completed year of service. Severance does not apply if an employee unreasonably refuses alternative work.
Australia
Under the Fair Work Act, redundancy pay applies to dismissals unrelated to performance or conduct. The tiers range from four weeks’ pay after one year to sixteen weeks after ten years. Casual workers and those with under 12 months’ service are excluded.
Poland
The Act on Collective Redundancies applies even if only one person is dismissed. Severance depends on tenure:
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One month’s pay (under 2 years)
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Two months (2–8 years)
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Three months (8+ years)
Employers sometimes gross up salaries to include overtime, which can affect final payouts.
Italy
Dismissals without “just cause” are heavily scrutinised. Courts may order reinstatement or damages. All terminated employees regardless of how they leave, receive TFR (Trattamento di Fine Rapporto) — an end-of-employment entitlement equal to roughly 7–8% of annual salary, accrued yearly.
Severance pay vs redundancy pay
While the two terms are often used interchangeably, they differ in scope.
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Severance pay covers any payment linked to an involuntary termination, whether redundancy or dismissal without cause.
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Redundancy pay applies specifically when a role is eliminated for operational reasons.
Some countries treat redundancy as a subset of severance, while others use separate systems.
For example, Australia defines redundancy pay in law, while the United States treats severance as contractual. Employers must understand which framework applies in each country where they operate.
Legal and tax considerations
Severance rules sit at the intersection of employment law, taxation, and compliance.
Legal status
In some countries, employers are legally required to pay severance. In others, it’s discretionary but enforceable if mentioned in the employment contract or employee handbook. Severance agreements can also create binding obligations once signed.
Taxation
In most places, severance pay is taxed as income, although certain jurisdictions apply exemptions or lower rates for redundancy. Some employees may spread payments over time to reduce tax impact.
Eligibility
Eligibility for severance depends on contract terms, tenure, and termination type. Employees dismissed for misconduct are rarely eligible. However, those made redundant or affected by a reduction in force typically are.
Interaction with unemployment benefits
In many jurisdictions, employees who receive severance can also claim unemployment benefits, though timing rules vary. Some systems delay benefits until the severance period ends to prevent overlap.
Documentation
Employers should retain all severance-related records — agreements, calculations, and communications — in case of later audits or disputes.
Severance agreements and post-employment clauses
A severance agreement outlines what the employee will receive and any conditions attached. It protects both parties and helps avoid future disputes.
Typical elements include:
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The amount and timing of the severance payment
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Release of claims or waivers of future litigation
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Confidentiality and non-disclosure agreement clauses
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Non-compete restrictions, where legally permitted
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Confirmation that both parties accept the terms as final
Employers often offer severance packages that include these agreements as part of responsible offboarding. Employees should always review them carefully and may wish to seek legal advice before signing.
How severance helps both sides
Severance helps employees by providing immediate financial relief, allowing them to plan their next step and maintain health insurance or other benefits temporarily. It also gives time to adjust, search, and find a new job without panic.
For employers, offering severance reduces the likelihood of lawsuits, protects brand reputation, and helps maintain morale among remaining staff. A fair process also demonstrates ethical leadership and commitment to compliance — qualities that build trust across the organisation.
Best practices for employers offering severance pay
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Document the policy clearly
Include severance rules in employment contracts and the employee handbook. Clarity helps prevent disputes later. -
Review local requirements
Severance rules differ dramatically. What’s optional in one country may be mandatory in another. -
Calculate accurately
Apply a transparent severance pay formula based on tenure and salary, and record how you calculated it. -
Communicate with empathy
Termination conversations are difficult. Clear explanations of the severance package can ease tension and preserve dignity. -
Provide support
Offering outplacement services or temporary benefits continuation helps employees feel valued and reduces reputational risk. -
Seek legal and payroll expertise
Employment and tax laws change frequently. Partner with local experts to stay compliant. -
Treat every case individually
Even with policy consistency, severance often depends on the employee’s role, contribution, and service. Handle discussions with care.
Common questions about severance pay
Is severance pay mandatory everywhere?
No. Some countries, such as South Africa or Poland, make it mandatory for redundancies. Others, like Germany and Finland, apply it through court orders or negotiations. In countries without statutory rules, companies choose to offer severance to manage risk and maintain fairness.
How long does severance last?
That depends on the severance pay formula and the length of service. Payments can cover a few weeks to several months of salary. Some packages also include benefits that continue temporarily.
How do you calculate severance?
Most employers calculate severance using years of service multiplied by a monthly pay rate. Some use a tiered system where longer-serving staff receive proportionally higher payments.
Do laid-off employees receive unemployment benefits?
In many jurisdictions, yes. However, eligibility may start only after severance payments are exhausted. Employees should check local unemployment rules.
Can an employee refuse a severance package?
Yes, employees may decline if they believe the terms are unfair or if signing would restrict future rights. For instance, some severance agreements that are offered to employees require waivers that they might not want to sign.
What happens to unused vacation or paid time off?
Most jurisdictions require payment for unused vacation or PTO when employment ends. This amount is often paid alongside severance.
Is severance pay taxable?
In nearly all countries, severance pay is taxed as income, though some apply reduced rates for redundancy compensation. Employees should review local tax rules before accepting terms.
What if a company doesn’t provide severance pay?
If severance is legally or contractually required, failure to pay may result in labour claims, fines, or reinstatement orders. Employees can often pursue remedies through local labour authorities.
Are all employees eligible for severance?
Eligibility varies. Some companies exclude short-term, probationary, or casual workers. However, permanent employees terminated due to business reasons generally qualify.
Can a severance agreement include restrictions?
Yes, but only within reason. Clauses like non-compete or non-disclosure must be lawful and proportionate to the role. Employees should review these carefully before signing.
Does offering severance affect morale?
Handled correctly, offering severance can actually strengthen morale by showing fairness and respect. Mishandled, it can create distrust. Transparent communication makes the difference.
Key takeaways
Severance pay is a core part of responsible offboarding that protects both employees and employers.
Severance packages can vary widely but often include pay, benefits continuation, and support services.
Employers are not always legally obligated, but many companies offer severance to reduce conflict and maintain fairness.
Calculating severance fairly, communicating openly, and following local law are essential to compliance.
A well-managed severance process helps employees move forward with dignity and keeps organisations compliant and respected.
