Going through a layoff can be a frightening experience. You may be worrying about your next source of income. There could also be a feeling of unworthiness, even if the company let go many other employees.
If you were lucky enough to get a severance package, it can give you financial support and help with the change. Whether you’re facing a layoff or negotiating terms, understanding severance packages is important. Knowing the details can help with moving your financial and emotional well-being forward.
Below we answer the most frequently asked questions regarding severance packages and how the details may impact you.
Q: What does a severance package include?
A: Severance packages vary by employer, but several components are commonly offered:
- Lump-sum or salary continuation payments: Most severance agreements include either a one-time lump-sum payment or continuing salary for a set period. The company often bases the amount on your tenure, such as one or two weeks of pay for each year of service.
- Payment for unused vacation or sick leave: Employers may compensate you for any accrued but unused vacation or sick days. Make sure to check how the company calculates this type of pay. Some companies may limit the payout or leave out certain types of leave, like sick leave.
- Health insurance continuation: Under COBRA federal law, you and your “qualified beneficiaries” may be eligible to continue your health insurance coverage for up to 18 months. Some employers fund part or all the premium for a limited time, which can be a valuable benefit. Otherwise, you may be responsible for paying the full premium plus a 2% administrative fee.
- Career transition services: Outplacement support, such as resume writing, job search coaching, or access to job boards, may be included to help you land your next role faster.
- Stock options or equity treatment: If you have stock options or equity, your severance package may address how these will be handled. Some companies accelerate vesting or extend the window to exercise options to give you ownership and more control.
- Retirement plan contributions or vesting acceleration: In some cases, employers may continue contributions to your 401(k) or pension plan or accelerate vesting schedules to ensure you retain more of your retirement savings. If your employer match takes five years to vest, and you leave after three years, you might only get the benefits for the three years you worked. While it may be tempting to pull money out of your 401(k) to cover lost income, ensure you understand withdrawal rules and penalties.
- Pro-rated bonuses: If you’re laid off mid-year, you might still be eligible for a portion of your annual bonus, depending on company policy and your performance.
Q: What questions should I ask about my severance package?
A: Before signing any severance agreement, it’s crucial to understand the terms and how they can affect your future:
- Getting a new job: Some packages include a clause that ends payments once you secure new employment. Clarify this up front to avoid surprises.
- Receiving unused leave: Ask for a breakdown of how your vacation or sick leave payout was determined, especially if you suspect discrepancies. You might also be able to get an estimate of the income to prepare for taxes.
- Earning benefits during the notice period: If you’re asked to work through a notice period, which is the amount of advance warning an employer must give before your job is officially terminated, confirm whether you’ll continue to accrue benefits like vacation or retirement contributions.
- Non-compete or rehire clauses: Some severance agreements include restrictions on working for competitors or being rehired by the company. Make sure you understand any limitations that could affect your ability to find the next source of income.
- Pension payouts: If you’re close to retirement, a layoff could impact your pension eligibility or payout amount. Check if the pension plan’s rules or vesting times will affect your payouts. You can do this by talking to your HR department or plan administrator.
Q: What tax implications will I need to consider?
A: Severance pay is considered taxable income, but how it’s paid can affect your tax situation:
- Taxing severance payments: A lump-sum payment may push you into a higher tax bracket for the year and increase your taxable income, while periodic payments might spread the tax burden more evenly.
- Withholding tax rates: Employers often withhold taxes at a flat rate, which may be lower than your actual tax liability. As a result, you could owe more when you file your return.
- Timing severance with other income: If possible, negotiate the timing of your severance to fall in a year with lower income, which could reduce your overall tax bill. If you lose your job in November, you might estimate it will take three months to find a new one. In that case, you might see if you can delay your severance until next year.
- Considering state-specific tax: Tax treatment of severance varies by state. Some states don’t tax severance pay at all, typically ones that have income tax, while others treat it like regular wages.
Q: When should I seek professional guidance?
A: While some severance packages are straightforward, others can be complex. Consider consulting a financial advisor, tax professional, or employment attorney if your termination involves:
- Equity or deferred compensation: Multi-layered compensation structures can have long-term tax and financial implications that require professional advice and a strategic approach for tax and liquidity optimization.
- Early retirement offering: Early retirement packages often come with trade-offs that should be carefully evaluated, such as reductions or delays in pension and Social Security benefits.
- Tax or rollover decisions: A tax or financial planning professional can help you avoid costly mistakes when managing severance, retirement accounts, or health benefits.
- Feeling emotionally overwhelmed: Losing a job is stressful. Professionals in mental health and financial advice can provide clarity and help you make informed decisions during a difficult time.
Creating a financial plan
In addition to creating a financial plan for managing your severance package, having a solid plan in place can help prepare you for any setbacks in the future. Financial planning is important for setting clear goals. It helps with creating a cash flow strategy and encourages wise saving. It also aids in making smart choices about borrowing, investing, and managing risks.
For example, cash flow management can help with planning for when different compensation components become liquid. These include RSUs, stock options, and deferred compensation. Investment management can assist with managing concentrated stocks to help reduce risk and major tax exposure.
Hiring a fiduciary like Mercer Advisors, who can collaborate with you on building a financial plan, may allow you to focus on your career or retirement rather than financial concerns. If you are facing a layoff and need to navigate your severance package, we can help you make confident and informed decisions. Let’s talk.
Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
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