Severance Pay vs Separation Pay: Are Both Legally Binding?

Lars Lofgren Avatar
Disclosure: Our content is reader-supported, which means we earn commissions from links on HR Advice. Commissions do not affect our editorial evaluations or opinions.

Yes, both separation pay and severance pay are legally binding once employees have signed an agreement and taken their pay. 

These types of payments are a way for employers to help employees transition to a new job in the event of termination.

But this compensation is just one part of the overall severance or separation package. Employers only offer a severance package under certain circumstances, like when an employee’s job is lost due to layoffs, redundancies, or company downsizing. 

Situations where an employee quits or gets fired usually don’t qualify for severance pay.

In this post, we’ll take a closer look at what qualifies as severance vs. separation pay and whether you should offer it.

What’s the Difference Between Severance Pay vs Separation Pay?

There’s not much of a difference between the two, honestly. One company might call it severance pay. Another will call it separation pay. 

Some argue that severance pay only covers layoffs and other things that happen for reasons outside the employee’s control. Separation pay, on the other hand, might cover everything from termination pay—more on that later—to severance pay. 

Keep in mind that in legal terms, separation has a broader definition than severance. In family law, it means two people decide to live apart while remaining legally married. Like a divorce, a couple in the middle of a legal separation will still make custodial arrangements and split their assets. 

And in constitutional law, separation refers to a division of powers across different branches of the US government.

Severance can technically have definitions outside the context of employment law, too. But it’s much more commonly associated with employment than any other type of legal situation.

What About Termination Pay? 

We said we’d come back to termination pay, so here’s a quick explanation of what it is. 

For some, it’s just another word for separation or severance pay. For others, it means pay given specifically in the case of a firing. 

And finally, it can also be a type of pay given in place of a required notice of termination. But this is mostly only relevant to the province of Ontario, Canada, where prior notice is required. The province’s Employment Standards Act says that termination pay is a minimum payment that can be given in place of a notice. 

You can learn more about following international labor laws in our guide to paying international employees

The federal government of the United States doesn’t have any required notice laws. And most states allow at-will employment, where either the employee or employer can terminate an agreement whenever they want and without prior notice. 

Several states do require termination letters, but these don’t need to be given beforehand. Rather, they’re handed out the date termination is effective. 

Should Companies Offer Severance Pay? 

Companies aren’t obligated to include pay as part of a severance package. At least not under the federal Fair Labor Standards Act. By and large, states don’t have severance pay laws either. 

But we think you absolutely should offer separation pay and a severance agreement for three key reasons: 

  • Lowers the likelihood of costly lawsuits. In a severance agreement, employers can require soon-to-be ex-employees to avoid legal action. In exchange, they give the employees a fair (or generous) severance package.
  • Reduces unemployment claims. Employees may still be able to file unemployment claims if they receive a severance package—it depends on the circumstances. But they might be less likely to do so. This can save an employer the pain of having money withdrawn from its state unemployment tax account. Any withdrawal can drive your unemployment tax rate higher, so this is a big deal.
  • Boosts morale. Getting laid off or terminated for any no-fault reason really sucks. Employees are likely to feel a mix of emotions when it happens, including panic, fear for the future, and anger—at you. But with a severance package, you signal to your employees that you care. It shows them they were valued members of your team, and now you want to help them ease into their next job with the essentials in hand—cash, health insurance, letters of recommendation, and the like. 

Of course, there’s an obvious downside to providing severance pay: it costs money. A generous severance package could include: 

  • One month of pay for each year the employee worked for the company. A five-year employee would get five months of pay. A one-year employee would get one. 
  • Health benefits for six months post-termination.
  • PTO payouts for accrued but unused PTO—see our guide to PTO payouts by state for all the laws you need to keep in mind.

A bare-bones package, on the other hand, might include: 

  • One week of pay for each year the employee worked for the company. So five weeks of pay for a five-year employee and one week for a one-year employee. 
  • No health benefits after the termination date. 
  • PTO payouts for accrued but unused PTO.

This would cost you a lot less, but it’s so little severance pay that it might not go over as well as a more generous package.

Employees aren’t obligated to sign a severance agreement. They can and probably will negotiate each and every point of one. 

Key Provisions in a Separation or Severance Agreement 

Severance agreements are usually drafted when a company knows it will be firing someone (or several someones). The HR department tends to be in charge of putting the document together. You can find all sorts of sample severance agreements and templates online, making the task relatively straightforward. 

But we recommend having an employment lawyer who knows the laws in your home state look over the agreement before you show it to an employee.  

A good severance agreement will include several provisions: 

  • Release of Claims: This is the provision that helps you avoid legal drama. It’s the part of the severance agreement where an employee waives their right to bring specific legal claims against an employer. The key thing to remember here is you must make the release of claims specific enough that it’s enforceable. Make sure you clarify exactly which rights are being waived and what you’re giving the employee in exchange. 
  • Severance Pay Details: Clearly outline how much severance pay you are offering and how you got to that number. Include whether you’ll be paying it in a lump sum or via installments. 
  • Continuation of Benefits: If you’re offering continued life and health insurance benefits, explain the terms of each one. Make sure you give employees account details for retirement benefits so they can roll them over with their next job.
  • Various Clauses: Some employers include a confidentiality clause to keep all terms of severance confidential. Others include a non-disparagement clause to prevent employees from speaking out negatively. A re-employment clause lays out the terms for what might happen if the company and the employee decide to join forces again in the future.
  • Acknowledgment of Full Understanding: This is the part of the contract where the employee agrees that they completely understand the severance agreement. They acknowledge they’ve had a chance to consult with a lawyer and fully understand the terms of the agreement. It’s basically a layer of extra protection built into the severance agreement. Just make sure you do actually give employees time to review, consider, negotiate, and get legal advice. Under the Older Workers Benefit Protection Act (OWBPA), you must allow a review period of at least 21 days for all employees over age 40. If you’re offering severance as part of an exit incentive to downsize your company, the employees get up to 45 days. Plus, there’s a seven-day period where these employees can revoke their signature. 

As you can tell, there are a lot of points to consider when putting a severance package together. 

That’s why it’s absolutely essential to have an employment lawyer review every severance agreement you create. 

If you don’t, you risk breaking laws you don’t know exist, which can put your company in boiling water. Like state sick leave payout laws that require you to cash out unused sick leave. Or that OWBPA law we talked about. 

Plus, you could leave out an important clause that invites unnecessary risk. 

So, we’ll say it one more time: have an employment lawyer review your severance agreement before you offer it to an employee. The fee will be worth every penny. 

It’s also well worth your time and money to invest in high-quality payroll software if you haven’t already. This reduces the risk of human error and makes it easier for you to figure out how much you can offer when it comes to severance pay. 

Build and Grow right from your Inbox

Scroll to Top