How Severance Pay Works: What You Need to Know Before You Sign

When a company undergoes restructuring or mass layoffs, they often offer departing employees a severance package. A severance agreement provides a financial cushion to help you transition between jobs, but it rarely comes without strings attached. In exchange for the payment, employers almost universally require you to sign a release of claims—meaning you agree not to sue them.

Before you put pen to paper, it is essential to understand exactly how severance works, how it will be taxed, and what your legal rights are, especially if you are over the age of 40.

Is Severance Required by Law?

One of the most common misconceptions about layoffs is that severance pay is a legal right. In the United States, no federal law requires an employer to provide severance pay [2]. The Fair Labor Standards Act (FLSA), which governs minimum wage and overtime, is entirely silent on the issue of severance.

There is, however, one major exception at the federal level: the WARN Act. If an employer conducts a mass layoff or plant closing without providing the required 60 days of advance notice, they are in violation of the WARN Act. The legal remedy for this violation is that the employer must provide up to 60 days of back pay and benefits to the affected workers—which functions very similarly to a mandatory severance package. Additionally, some state “mini-WARN” laws (like New Jersey’s) explicitly mandate severance pay for mass layoffs [2].

Outside of those specific scenarios, severance is entirely at the discretion of the employer, unless it is written into your employment contract or a collective bargaining agreement.

How Much Severance Is Normal?

Because it is not federally regulated, severance packages vary wildly from company to company. However, corporate HR departments typically rely on a standard formula based on your tenure with the organization.

The most common formula is one to two weeks of base pay for every year of service.

For example, if you worked at a company for five years, a standard severance offer would likely be between five and ten weeks of your base salary. Executives and C-suite leaders often have different, more lucrative formulas explicitly outlined in their employment contracts.

How is Severance Pay Taxed?

A nasty surprise for many laid-off workers is the tax hit on their severance check. Just like a PTO payout, the IRS classifies severance pay as “supplemental wages.”

Supplemental wages are subject to a flat 22% federal withholding rate. In addition to the 22% federal tax, you must also pay standard FICA taxes (6.2% for Social Security and 1.45% for Medicare, totaling 7.65%).

Combined, nearly 30% of your severance check will be withheld for federal taxes, plus whatever your state charges for state income tax. It is crucial to factor this in when budgeting your post-layoff finances.

Critical Protections for Workers Over 40 (OWBPA)

If you are 40 years of age or older, you are granted special protections under a federal law known as the Older Workers Benefit Protection Act (OWBPA), which is an amendment to the Age Discrimination in Employment Act (ADEA) [1].

Because employers use severance agreements to protect themselves from age discrimination lawsuits, the OWBPA ensures that older workers are not pressured into signing away their rights blindly. For a severance agreement to be legally valid for a worker over 40, it must meet several strict requirements [1]:

1. Time to Consider: You must be given at least 21 days to consider the agreement. If you are part of a group layoff (defined as two or more employees being let go), that consideration period is extended to 45 days.
2. Right to Revoke: Even after you sign the agreement, you have a strict 7-day revocation window. You can change your mind and cancel the agreement within those 7 days, and the employer cannot stop you. The agreement does not technically go into effect until this 7-day period expires.
3. Explicit Waiver: The document must explicitly state that you are waiving your rights under the ADEA.
4. Legal Counsel: The employer must advise you in writing to consult with an attorney before signing the agreement.

If an employer hands a 45-year-old employee a severance agreement and demands they sign it by the end of the day, that agreement is legally invalid under the OWBPA.

Should You Negotiate Your Severance?

Severance agreements are legal contracts, and like any contract, they can often be negotiated. If you believe you were terminated wrongfully, or if you simply want to ask for an extended period of paid health benefits (like COBRA premiums), you can counter-offer.

Before you sign any severance agreement—especially if it includes a non-compete clause or a non-disparagement clause—it is highly recommended that you take advantage of your 21-day review period and consult with a local employment attorney to ensure your rights are protected.