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Severance Pay: How It Works and Who Is Entitled to It

Severance pay is often confused with redundancy pay, as both are a form of financial settlement for departing employees. As an employer, it is important that you understand the distinction between the two. This will help ensure smooth operations, happy employees and legal compliance.

In this post, we will look at what severance pay is, who is entitled, and how it works. We will also discuss some of the laws surrounding severance pay packages in the UK, and what you need to consider when you calculate an employee’s severance payment.

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What Is Severance Pay

Severance pay is a form of compensation paid to an employee on the early and unwilling termination of their contract. It applies when an employee is dismissed through no fault of their own. This can be due to restructuring in the company or when a position is felt to no longer be required for operations to run.

The amount an employee receives usually depends on the length of their employment and on the policies detailed in a company’s employee handbook. Generally speaking though, a severance payment usually includes payment in lieu of notice, accrued holidays, pension payments, and additional bonuses or discretionary amounts where appropriate.

Although severance pay isn’t a legal requirement in the UK, companies that offer it gain a competitive advantage and attract and retain more talent. Severance agreements also protect you against potential lawsuits relating to a dismissal.

How Does Severance Pay Differ To Redundancy Pay?

Redundancy and severance pay are two different forms of compensation. Redundancy is a basic amount that you must pay an employee if you make them redundant. According to the Employment Rights Act 1996, 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); or
  • the duties undertaken by an employee are no longer required by the company (due to changes in business needs).

Statutory redundancy payments depend on an employee’s contract and length of service, as well as the reasons for dismissal.

Severance pay, in contrast, is a larger package that includes redundancy pay where appropriate. But it also includes any other payments due to a departing employee, including benefits and bonuses. Whereas redundancy pay is regulated by law, it is up to you to negotiate severance packages with your employees.

Checking Your Redundancy Rights

When you make an employee redundant due to changes in the business (restructuring, relocating or downsizing) there are a number of things you need to consider. Firstly, you can only make an employee redundant if you can prove that their services are no longer required by the company. If you dismiss an employee due to misconduct or performance issues then they are not eligible for redundancy pay.

The next thing to consider is whether the redundancy is compulsory or non-compulsory. With compulsory redundancy, you must follow fair selection criteria and ensure you don’t discriminate. You must follow ‘collective consultation’ rules if you’re making 20 or more employees redundant within any 90-day period at a single establishment. If you don’t, an employment tribunal could decide that you’ve dismissed your staff unfairly.

If you dismiss an employee on the grounds of business changes then you must pay them a redundancy settlement if they have been with the company for a minimum of two years. You must also pay them for all accrued wages and holidays, payments in lieu of notice where appropriate, and any negotiated bonuses (their severance payment).

Severance Pay UK

As an employer, you should have a clear policy in place that details how severance pay is managed at your company. As there are no legal requirements, your severance policy will depend on you. It should, however, clearly outline which employees are eligible for severance packages, and what the parameters and requirements are. It should also include a breakdown of which benefits and payments you will include in your severance packages, and how many weeks’ paid notice employees will receive according to length of service.

If you decide to offer an employee a voluntary severance package then you need to make sure they 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 so that departing employees don’t disclose the terms of their severance package.

Severance Laws

When it comes to redundancies, the law is clear. If you make an employee redundant, you must pay them a redundancy settlement if they have been with you for at least two years. The amount you pay them will depend on their length of service (capped at 20 years) and age:

  • 21 and under – 0.5 week’s pay for each full year of service
  • 22 to 40 – one week’s pay for each full year of service
  • 41 and above – 1.5 week’s pay for each full year of service

As of the 6th of April 2020, the law has capped weekly pay at £538. The maximum statutory redundancy settlement you can pay an employee is £16,140.

But things are not so clear when it comes to severance pay. There are no severance laws in the UK, so there is no legal obligation to define a severance policy. However, you might want to consider doing so as it safeguards your company from potential unfair dismissal claims. A generous severance pay policy can also help attract and retain talent, especially at an executive level. It is up to you to decide what guidelines you include in your severance policy.

severance pay

How To Calculate Severance Pay

If you make an employee redundant due to business or operational changes then you must pay them a redundancy settlement. When it comes to severance pay, it is up to you how you calculate it. Will you offer severance pay to all dismissed employees? Or just those at an executive level? Which benefits will you include? Whatever you decide, you need to clearly define it in your redundancy and severance policy. You also need to make sure all existing and new employees have access to the policy.

A solid, reliable document management system can help you streamline and process your severance pay policy and procedures. Factorial’s document management feature can help you create and distribute your severance pay policy so that your employees are aware of their rights. It can also help you coordinate a departing employee’s severance pay with payroll, tax deductions and accrued holidays so that you can be sure that they are paid the right amount when they leave your company. The simple tool can help you boost your HR management processes. It can also help you implement a fair and robust policy for managing redundancies and severance payments at your company.

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