As a business owner or hiring manager, you’ve done the hard work of growing your team, managing change, and navigating the ups and downs of the marketplace. So when the time comes to part ways with an employee, whether through layoff, restructuring, or mutual separation, having a well-designed severance package in hand can make a difference. In this guide, we’ll walk you through what a severance package is, why you might offer one, how to structure it, the key legal risks to avoid, and how to align it with your company’s culture and brand.
What Is a Severance Package?
When you hear “severance package,” what typically comes to mind might be a check, a handshake, and a firm pat on the back. But for employers, it’s more than that. At its core, a severance package is a tool: a voluntary offering of pay and benefits to a departing employee. It’s intended to provide a financial cushion, ensure a smoother transition, and protect your business from legal and reputational risk. It’s most common during layoffs, downsizing, or reorganizations, but can also apply when someone leaves voluntarily under a mutual separation agreement. Severance packages usually are not mandatory for employers, but if you choose to offer one, the key is to make it thoughtful, transparent, and legally sound.
Why Offer a Severance Agreement
There are several strategic reasons why offering severance packages is a smart business move:
- Employee goodwill and morale: A severance package shows long-term and senior employees that you value their contributions and leaves a positive impression on the rest of your team.
- Mitigating legal risk: Severance packages can be tied to releases of claims, confidentiality or non-disparagement obligations, and can help reduce the odds of costly employment claims.
- Protecting reputation and brand: How you handle employee departures says a lot about your company. A smooth, respectful exit can strengthen your employer brand, while a poorly managed one has the potential to harm your business reputation.
- Facilitating business transactions or restructuring: When preparing for a business sale or reorganization, settling employment matters early with clear separation and severance terms can help prevent issues and ease the transition.
What Should a Severance Package Include?
There’s no single “right” package. But many effective severance agreements include these key elements:
- Severance payment: A lump sum or payments based on years of service. For example, a standard formula might be two weeks of pay for each year of service.
- Benefits continuation: Extending health insurance, life insurance or other benefits for a defined period (sometimes with the employer subsidizing the premiums).
- Accrued PTO/vacation payout: Whether unused vacation must be paid out depends on both state law and your company’s policy. Some states require payout; others do not.
- Outplacement or career-transition services: For higher-level employees, providing résumé help, coaching, or job-search support can help both parties.
- Stock‐option vesting or other equity treatment: For senior executives or key employees, prorata vesting or exercise windows may be included.
- Release of claims and other protections: A written agreement that the employee waives specific claims, returns company property, respects confidentiality, and agrees to non-disparagement or non-solicitation terms.
When designing your package, you should consider what is appropriate given the employee’s tenure, role, and the business context. A clean, simple offering might be fine for a junior staff member, but a more generous one may be wiser for a senior leader.
Designing a Fair and Consistent Policy
If your company plans to offer severance packages on more than an individualized basis, it’s a good idea to create a clear policy. Here are a few practical tips for shaping your policy:
Decide who’s eligible. Spell out who qualifies for severance—full-time employees only, or part-time too? Will you set a minimum length of service? What about situations involving misconduct or policy violations?
Set simple, transparent guidelines. A common approach is to offer one week of pay for each year of service, capped at a certain number of weeks. You can always make exceptions for senior leaders, but it helps to start with a clear baseline.
Clarify benefit extensions. Note how long health insurance or other benefits will continue, and whether your company will cover all or part of the cost.
Define the treatment of unused PTO/vacation. If your policy is not to pay out unused time, be sure your handbook clearly states this and that the policy complies with state law.
Reference the employment separation agreement. The severance policy should reference that the offer is contingent on a signed agreement, including a release of claims and other standard terms.
Ensure consistent treatment. If you make exceptions, document the business rationale so you aren’t opening the door to claims of discrimination or unequal treatment.
Update the policy periodically. Policies should be reviewed and updated periodically to ensure compliance with evolving employment laws. Non-compete enforcement, for example, is an area of rapid change.
Know the Legal Basics
Even a solid severance package can backfire if you overlook key legal issues. Here are some important points you should keep in mind:
You don’t have to offer a severance package. In the U.S., severance pay is not generally required by federal or state law, unless you’ve promised it in an employment contract or policy, or you’re subject to a statute such as the Worker Adjustment and Retraining Notification Act (WARN Act), which applies to employers with 100 or more full-time employees in mass-layoff situations.
Avoid unintentionally creating an ERISA-covered plan. If you repeatedly offer severance in a consistent way and designate eligibility rules, your severance package might be treated as a “welfare benefit plan” under the Employee Retirement Income Security Act (ERISA). This designation brings additional record-keeping requirements, fiduciary obligations, and potential liability. Having an attorney review your plan in advance can help ensure it is structured to avoid these obligations.
Understand severance pay laws by state. Every state has its own rules regarding final wages, payout of vacation, age discrimination waivers, and more. If your business operates in multiple states, make sure your agreements are tailored to comply with the laws in each jurisdiction.
Be aware of releases, age discrimination, and waiver requirements. If your severance agreement asks the employee to release age-related claims (e.g., under the Tennessee Human Rights Act (THRA) or Age Discrimination in Employment Act (ADEA)), ensure that you follow the special disclosure and time-period requirements that apply under applicable law.
Don’t forget about non-competes, non-solicitation, and confidentiality clauses. These clauses are often included in severance agreements. However, an overly broad non-compete or a poorly drafted confidentiality clause could make the entire agreement unenforceable. Consulting an attorney when drafting or reviewing these provisions can help ensure they are enforceable and compliant with applicable laws.
Don’t forget about tax and wage-and-hour concerns. Severance payments may trigger tax withholding and are often treated as supplemental wages. You also want to make sure that any deduction or offset (for example, unused PTO) doesn’t violate wage-and-hour laws.
Practical Steps for Employers Before Offering Severance
Here’s a checklist to help you move forward with confidence when crafting or offering a severance package:
Review your employee handbook and employment contracts. Do you have any existing policies regarding severance, PTO payout, or benefit continuation?
Define your business objective. Are you offering severance to ease downsizing, protect against claims, or incentivize a smooth transition post-restructuring?
Determine appropriate terms. Tailor the payment, benefits, and other elements to reflect the employee’s role, tenure, and reason for separation. Larger roles generally merit more generous terms.
Draft the separation agreement. Include clear release language, confidentiality/non-disparagement clauses (if desired), property return, and applicable non-compete or non-solicitation terms, in compliance with state law.
Ensure compliance with multi-state obligations. If your company operates in multiple states, ensure that all policies and separation agreements comply with applicable law in each jurisdiction.
Decide on the message and timing. Plan how you’ll communicate the separation. A positive, respectful tone helps maintain brand integrity and protects morale among remaining employees.
Align internal stakeholders. Coordinate HR, payroll, benefits, and legal to ensure consistency in the timing of benefit continuation, payment method, and documentation.
Document everything. Keep records of the agreement, calculations supporting the severance payment, proof of return of company property, and any disclosures required under applicable law.
Monitor follow-through. Post-separation, ensure COBRA notices are sent out (if applicable), benefits terminate or continue as promised, and any obligations under the separation agreement are monitored.
Review and update your policy periodically. Employment law evolves. For example, non-compete enforcement is changing fast, so staying up to date is essential.
Special Considerations During Sale or Restructuring
If your business is undergoing a sale, merger, or major restructuring, severance planning takes on added complexity — and added opportunity.
- You may want to terminate employment relationships ahead of a sale to provide a clean break and minimize buyer liability. But this incurs costs (severance payments, payouts, benefit obligations) and may delay the transition.
- Crafting severance agreements in this context can lock in waiver of post-closing claims, ensure return of proprietary information, and align with the timeline of the deal.
- Given the higher stakes, customizing severance agreements by state, by employee category, or by role can be worthwhile. One-size‐fits‐all in multi-state, multi-role settings may expose you to unintended risk.
Leading With Fairness and Foresight
Designing and offering a severance package requires attention to detail and proactive planning. As an employer in Tennessee, you’ll want to:
- Think strategically about why you’re offering severance.
- Build a fair, transparent, and appropriate package for each situation.
- Ensure compliance with federal and state employment laws.
- Document intent, execution, and follow-through.
- Consider the broader impact on employee morale, company culture, and your brand.
At Hudson, Reed & Christiansen, PLLC, we help business owners and HR professionals across Middle Tennessee create severance policies, draft separation agreements, and navigate employment issues with confidence.
If you’re facing a layoff, restructuring, or just want to be proactive about your severance practice, let’s talk. We can help you protect your business and respect your departing employees.
FAQs for Employers
Q: Is severance pay required by law?
A: In most cases, no. Neither federal nor Tennessee law requires severance pay unless it’s promised in a contract or company policy. However, once you’ve made it a standard practice, you must apply it consistently to avoid the risk of discrimination claims.
Q: How much severance should I offer?
A: It depends on your company’s budget, size, and the employee’s role. A common formula is one or two weeks of pay per year of service, but executives or long-term employees often receive more.
Q: Can severance agreements include non-compete clauses?
A: Yes — but be cautious. Non-competes must be narrowly tailored to your industry, geography, and duration. Overly broad restrictions can be unenforceable (and may invite legal challenges).
Q: What’s the difference between a severance package and a severance agreement?
A: The package is what you’re offering — pay, benefits, or other perks. The agreement is the legal document that the employee signs to accept, typically including confidentiality, release of claims, and other terms.
Q: When should I consult an attorney?
A: Ideally, before you make any offer. An employment attorney can review your severance policies, tailor agreements to your state’s laws, and ensure you’re protecting your business while treating employees fairly.
Q: What if we’re laying off several people at once?
A: For larger layoffs, you may have obligations under the federal WARN Act, which requires advance notice or pay in lieu. It’s especially important to coordinate with legal counsel during group terminations.
Can Offering Severance Backfire?
It can, if it’s handled inconsistently or drafted poorly. Ambiguous language, unfair application, or missing legal disclosures can all cause problems later. A clear, well-documented process avoids that.
Need help developing or reviewing a severance policy? Hudson, Reed & Christiansen’s employment law team helps Tennessee employers design agreements that protect both people and business. Contact us to start the conversation.