Pay & Salary

What is Severance Pay and How Is It Calculated?

July 26, 2021

Losing a well-paid job or a steady source of income may present a challenging experience for many employees. To address this challenge, employers offer payments to employees who cease employment. Severance pay and redundancy pay are two common payments employers make when terminating employees' contracts. Knowing what these are, when they're paid, and how employers determine them can help you plan for your job exit. In this article, we describe severance pay in detail so can understand how it affects you.

Related: The Essential Guide to Redundancy Payouts and Redundancy Notice Periods

How is severance pay determined?

The amount of severance pay an employee gets depends on their continuous period of service with their employer. Continuous service is a period of unbroken service. The amount is paid at the employee's base rate for the ordinary hours they've worked. This refers to the pay rate they get for working their usual hours.

Redundant employees are also entitled to outstanding wages, accumulated annual leave and long service leave due upon termination. However, it doesn't include incentive-based payments or bonuses, overtime pay, monetary allowance, or other separately identifiable amounts.

How to calculate severance pay?

The amount of compensation that the company offers the employee is usually determined by how long they work for the company, the company's size and their rank or position. To calculate severance pay, the hiring manager takes a couple of weeks' salary and multiplies it by the number of years the employee has worked for the company. Some employers may base the calculation on four weeks' salary for the years worked.

The table below outlines the years of continuous service and the corresponding redundancy pay under the National Employment Standards (NES):

  • One year but less than two years: four weeks' pay
  • Two years but less than three years: six weeks' pay
  • Three years but less than four years: seven weeks' pay
  • Four years but less than five years: eight weeks' pay
  • Five years but less than six years: 10 weeks' pay
  • Six years but less than seven years: 11 weeks' pay
  • Seven years but less than eight years: 13 weeks' pay
  • Eight years but less than nine years: 14 weeks' pay
  • Nine years but less than 10 years: 16 weeks' pay
  • At least 10 years: 12 weeks' pay

Example of severance pay:
If you were employed by a company for 8 years and you earned $800 per week and your employer granted you a severance of 3 week's pay for each year you worked with them, your severance pay would be:
$800 per week x 3 weeks) x 8 years (years at company). The total of your severance pay is $21,600.

Related: How Are Redundancy Payments Calculated?

Why do you get severance pay?

Companies usually offer severance pay during layoffs, retirement and when there is job elimination or loss. However, the company has the sole discretion to decide whether to provide the parting employees with severance pay. For example, if a company has been laying off staff due to organisational changes or adjustments, the employees may not qualify for severance pay automatically.

Employees can also get severance pay for sudden termination of their employment. In this case, the company may opt to offer the affected employees severance pay for these reasons:

  • Stop employees from suing the company for unpaid wages, wrongful termination, or discrimination.
  • Severance pay was part of the employee's contract when the job offer was made to them
  • As a sign of goodwill compensation to employees leaving the company
  • On condition that exiting employees don't say or write anything negative about the company and its leadership

Severance pay for redundancy

Employees can also get severance pay when their work ends or get terminated by way of redundancy. The amount of redundancy payment they get may depend on factors such as their length of service with a company, the size of the company, and industry-specific redundancy schemes that apply.

If a company intends to sack a huge number of employees but fails to provide sufficient notice of the impending layoffs to employees, the individual employees are legally entitled to pursue severance pay. Employees who lose their jobs due to poor performance are not usually eligible for severance pay. Check state and national laws regarding severance pay before you take any action.

What is the meaning of severance pay?

Severance pay refers to the compensation that an employee gets when their job contracts end early. It applies to situations where an employer terminates an employee early. When the employee ceases working for the company, they may get a lump sum payment. Common examples include contractual termination payments, payments in compensation for loss of employment, golden handshakes, and payment for unused sick leaves and roster days off.

Some employers may include redundancy payments and additional entitlements like health insurance coverage for a specific period until the employee finds new work. The amount of severance pay that an employee is entitled to depend's on the number of years they have been in their role. The Fair Work Act 2009 generally stipulates the minimum entitlements in respect of notice of termination and the resulting redundancy pay for affected employees.

Related: How To Deal With Job Loss

What is the difference between severance pay and redundancy pay?

Severance pay is a type of compensation that employee gets from their employer when their work ends suddenly. It's usually based on the number of weeks or duration of employment. Redundancy pay is the money that an employee gets when their job or position in the company is no longer required. In most cases, it's a one-off goodbye payment. For redundancy to be legal, it has to be genuine. In other words, the job itself no longer exists.

Employees must have been employed for at least one year and the business needs to have at least 15 or more employees at the time employees are becoming redundant. Redundancy may happen when a company becomes insolvent, moves services overseas, undergoes corporate restructuring or automates some jobs. It's an aspect of severance pay. While the two terms appear similar, they're technically different. As part of redundancy pay, the employer might also make decide to make payouts for unused long service leave, accrued annual leave or money that's due for the work done. How much redundancy pay the employee gets varies depending on the number of years they work with a company. Casual employees and employees who work for small businesses are not eligible for redundancy pay.

Frequently asked questions about severance payment

Maybe your employee has sent you a notice of termination but hasn't clarified some issues that might affect your payment. Below we provide answers to some of the common questions on redundancy entitlements and severance package:

When do I get my severance pay?

You should receive your severance pay or redundancy entitlement when you finish work or at the next regular payday. It could be a week or a month, depending on your employer's pay cycle.

Will I pay tax on redundancy?

Whether you left your job voluntarily or otherwise, the severance pay you receive upon termination of your work contract is taxable. However, any amount that you receive as severance pay, and that meets the conditions of genuine redundancy, is tax-free up to a certain limit depending on the years of service. The limit is in dollar amount and includes each additional year of completed service during employment tenure.

How is a redundancy payment calculated?

You can calculate your severance or redundancy payment using any of the relevant awards or under the National Employment Standards (NES). The amount of pay depends on your period of continuous service with a company.

Does a redundancy payment count as income?

Redundancy payments that meet the condition of genuine redundancy aren't subject to tax. The amount is calculated based on the number of whole years of service and not on a pro-rata basis for the years worked. Your employer will report the tax-free severance pay as a lump sum in your income statement or pay as you go summary.

How many weeks per year do I get for redundancy?

The number of weeks you get for redundancy depends on the duration of continuous service. For example, you may get six weeks of pay if you worked for two years but less than three.

How long is a redundancy notice period?

A company has to provide all redundant employees with written notice of the particular day that their job ends. How much notice they can give the employee usually depends on the nature or terms of employment in accordance with the Fair Work Act and their length of service. Once the employer issues the notice, they have to pay the employee instead of the notice period.

What's a genuine redundancy?

A genuine redundancy is when a company doesn't require someone to do the employee's work or the business becomes bankrupt. For a redundancy to become genuine, the company has to consult with the affected employees according to the terms of the registered agreement or applicable award. In addition, there must not be any other existing role within the company or business that employees might perform.

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