Severance Agreement for Small Business: How It Works
Quick Answer
A severance agreement is a written contract where an employer offers pay or benefits to a departing employee, usually in exchange for the employee releasing legal claims. Federal law doesn't require severance pay; the Department of Labor says it's a matter of agreement between employer and employee. If the agreement waives age discrimination claims for an employee 40 or older, federal rules require specific terms, including at least 21 days to consider (45 for a group program) and 7 days to revoke after signing. Agreements can't stop employees from filing a charge with the EEOC or taking part in an EEOC investigation.
Letting someone go is never easy, especially in a small business where everyone knows each other. A severance agreement can make the transition smoother for both sides: the employee gets financial support while they look for the next job, and the business gets clarity and, usually, a release of legal claims.
But severance agreements are legal documents, and the details matter. This guide explains when severance makes sense, how much to offer, what to include, the special federal rules for employees 40 and older, what an agreement can't do and how to handle final pay and benefits. It includes a template outline you can review with your attorney.
Note: This is general information, not legal advice. Severance agreements are contracts with legal consequences, and state laws vary. Have an employment attorney draft or review any severance agreement before you offer it.
Is Severance Pay Required?
Generally, no. The Department of Labor says there is no requirement in the Fair Labor Standards Act (FLSA) for severance pay, and that severance pay is a matter of agreement between an employer and an employee.
Severance may be required, or expected, in some situations:
- An employment contract or offer letter promises severance.
- A written severance policy or plan in your handbook or benefits documents.
- A past practice of paying severance that employees reasonably rely on.
- A union contract that includes severance terms.
- Some state or local laws related to large layoffs or specific industries.
If you have an established severance plan, the Department of Labor notes that its Employee Benefits Security Administration may be able to assist an employee who did not receive severance benefits under an employer-sponsored plan. Follow your written plan consistently.
Why Small Businesses Offer Severance
- A release of claims. The main business reason: the employee agrees not to sue over the employment or the separation.
- A smoother exit. Financial support reduces anger and uncertainty.
- Reputation. How you treat departing employees affects the team that stays and future hiring.
- Transition help. Severance can be tied to returning property or helping hand off work.
- Fairness in a layoff or elimination of a role that isn't the employee's fault.
Severance vs. Final Pay
Severance is separate from wages the employee has already earned. Final pay must be paid on time under your state's rules whether or not the employee signs anything. Never make earned wages conditional on signing a release.
| Payment | Required? | Conditional on signing? |
|---|---|---|
| Final wages for hours worked | Yes | No, never |
| Earned commissions or bonuses | Depends on agreements and state law | Generally no |
| Accrued PTO payout | Depends on your policy and state law | Generally no |
| Severance pay | Only if promised by contract, policy or law | Yes, usually |
See final paycheck laws by state and which states require vacation payout upon termination.
How Much Severance to Offer
There's no legal formula. Common approaches:
| Approach | Example | Considerations |
|---|---|---|
| Weeks per year of service | 1 to 2 weeks of pay per year worked | Easy to explain and apply consistently |
| Flat amount by role | 2 weeks for hourly staff, 4 to 8 weeks for managers | Simple, but check for consistency |
| Minimum plus service | 2 weeks minimum plus 1 week per year | Helps short-tenure employees |
| Case by case | Based on risk and circumstances | Flexible, but harder to keep fair |
Whatever you choose, be consistent. Offering very different packages to similar employees can raise discrimination concerns. Severance must also be something of value beyond what the employee is already entitled to receive, which is a legal requirement for a valid age discrimination waiver.
Other Things You Can Offer
- Payment toward health coverage continuation for a period.
- A neutral reference or agreed reference language.
- Outplacement or job search support.
- Letting the employee keep a laptop or phone.
- Agreed wording for how the departure is announced.
What to Include in a Severance Agreement
| Section | What it covers |
|---|---|
| Separation date | The employee's last day of employment |
| Severance terms | Amount, payment schedule and any benefits |
| Final pay acknowledgment | Confirms final wages are paid separately |
| Release of claims | What claims the employee is giving up |
| Rights not waived | Agency charges, unemployment, vested benefits and others |
| Age discrimination terms | Required terms for employees 40 and older |
| Return of property | Keys, equipment, files and accounts |
| Confidentiality and non-disparagement | If used, written carefully and reviewed by counsel |
| Reference | How reference requests will be handled |
| Review and revocation periods | Time to consider and revoke |
| Advice to consult an attorney | Written recommendation to get legal advice |
| Signatures and dates | Both parties sign |
Special Rules for Employees 40 and Older
The Age Discrimination in Employment Act (ADEA) protects employees 40 and older. If a severance agreement releases age discrimination claims, federal regulations at 29 CFR 1625.22 require the waiver to be knowing and voluntary, and set minimum requirements:
- Written in plain language the employee can understand.
- Specifically refers to rights or claims under the ADEA.
- Doesn't waive future claims that arise after the agreement is signed.
- Provides something of value beyond what the employee is already entitled to.
- Advises the employee in writing to consult an attorney before signing.
- Gives at least 21 days to consider the agreement, or 45 days for a group exit incentive or termination program.
- Gives at least 7 days after signing to revoke, and the agreement isn't effective until the revocation period ends.
An employee may sign before the 21 or 45 days are up, but only if that choice is knowing and voluntary and not induced by the employer. The 7-day revocation period can't be shortened.
Group Layoffs
When two or more employees are offered severance as part of a group exit incentive or termination program, extra disclosure rules apply. The employer must give each person written information about who was covered, eligibility factors and time limits, and the job titles and ages of those selected and not selected in the decisional unit. These disclosures are detailed, so work with an attorney on any group layoff. See layoff vs furlough vs termination.
What a Severance Agreement Can't Do
Some rights can't be signed away, and trying to do so can make provisions unenforceable:
- EEOC charges and investigations. The EEOC says a provision that attempts to prevent employees from filing a charge with the EEOC or participating in an EEOC investigation is invalid and unenforceable.
- Future claims. For age discrimination, the waiver can't cover claims that arise after signing.
- Earned wages. Final pay for work already done can't be made conditional on signing.
- Other agency rights. Many agencies protect employees' ability to report concerns or cooperate with investigations. Have your attorney include a clear "rights not waived" section.
Broad confidentiality and non-disparagement clauses deserve particular care, because some can conflict with employee rights under labor and whistleblower laws. Ask your attorney how to word them. See whistleblower and anti-retaliation policy.
Health Insurance and Benefits
Losing health coverage is one of the biggest worries for a departing employee. The Department of Labor says COBRA gives workers and their families who lose their health benefits the right to choose to continue group health benefits for limited periods, and that it generally covers group health plans of employers with 20 or more employees in the prior year. Covered individuals may have to pay up to 102% of the cost. Some states have their own continuation rules, so check with your benefits provider.
Some employers include a set number of months of premium help in the severance package. Check with your benefits provider about how coverage ends and what notices are required.
How to Present a Severance Offer
- Prepare in advance. Have the agreement reviewed and final pay ready.
- Meet privately with a second person present when possible.
- Communicate the decision clearly and kindly. See what to say when terminating an employee.
- Explain the offer and the time to review it.
- Don't pressure the employee to sign on the spot.
- Provide the agreement in writing and encourage them to talk with an attorney.
- Answer practical questions about final pay, benefits and property.
- Follow up in writing with key dates.
Sample language: "We've made the decision to eliminate your position, effective today. This isn't about your performance. Your final paycheck, including all hours worked through today, will be paid on [date]. We'd also like to offer you a severance package of [amount] in exchange for signing this agreement. You have [21] days to review it, and we encourage you to talk with an attorney. If you have questions, you can reach me at [contact]."
Free Severance Agreement Template Outline
Severance Agreement and General Release (outline for attorney review)
1. Parties: [Company] and [Employee].
2. Separation date: Employment ends on [date].
3. Final pay: Employee will receive all wages earned through the separation date [and accrued PTO, if applicable] on [date], whether or not Employee signs this Agreement.
4. Severance: If Employee signs and does not revoke this Agreement, Company will pay [amount], less applicable withholdings, [in a lump sum / in installments] beginning [date]. [Optional: Company will pay [months] of health continuation premiums.]
5. Release: Employee releases Company from claims arising from employment or separation through the date of signing, including claims under [list laws, including the Age Discrimination in Employment Act if applicable], except as stated in Section 6.
6. Rights not waived: This Agreement does not waive rights that cannot be waived by law, claims arising after signing, rights to vested benefits, unemployment or workers' compensation benefits, or the right to file a charge with or participate in an investigation by the EEOC or another government agency.
7. Return of property: Employee will return all company property by [date].
8. Reference: Company will [confirm dates of employment and position only / provide agreed reference].
9. [Confidentiality and non-disparagement, if any, as drafted by counsel.]
10. Review and revocation: Employee has [21/45] days to consider this Agreement and 7 days after signing to revoke it by notifying [contact] in writing. This Agreement becomes effective on the 8th day after signing if not revoked.
11. Attorney advice: Company advises Employee to consult an attorney before signing.
12. Signatures and dates.
This outline is a starting point for discussion with your attorney, not a finished agreement. State laws and your specific situation will affect the final language.
Common Severance Mistakes
- Holding final pay hostage until the release is signed.
- Missing ADEA requirements for employees 40 and older.
- Pressuring employees to sign immediately.
- Inconsistent packages for similar employees.
- Overbroad confidentiality or non-disparagement clauses.
- Trying to block agency charges or investigations.
- Forgetting benefits notices and continuation coverage.
- Using a template from the internet without attorney review.
Severance Agreement Checklist
| Step | Done? |
|---|---|
| Check contracts, policies and past practice for severance promises | |
| Decide the severance amount consistently | |
| Prepare final pay separately | |
| Include ADEA terms for employees 40 and older | |
| Include a "rights not waived" section | |
| Have an attorney review the agreement | |
| Plan the conversation and give time to review | |
| Handle benefits, COBRA or state continuation notices | |
| Collect company property and close accounts |
Example: Eliminating a Role in a Small Business
A 20-person landscaping company decides to eliminate its office coordinator role after moving scheduling to software. The coordinator, Pat, is 52 and has worked there six years. The owner decides to offer two weeks of pay per year of service, which comes to 12 weeks, plus three months of help with health coverage premiums.
Because Pat is over 40 and the agreement releases age discrimination claims, the attorney includes the required ADEA language, a written recommendation to consult an attorney, 21 days to consider and 7 days to revoke. Pat's final paycheck, including all hours worked and accrued PTO under the company's policy, is paid on the next regular payday regardless of whether Pat signs. Pat signs on day 10, the revocation period passes without a change, and severance is paid on the following payroll.
Paying Severance: Practical Details
- Lump sum or installments. A lump sum is simple. Installments keep the employee on a payment schedule and can be paired with the return of property.
- Tax withholding. The IRS says severance payments are wages subject to Social Security and Medicare taxes, federal income tax withholding and FUTA tax. Run severance through payroll.
- Timing. Don't pay severance until the revocation period has passed without a revocation, if one applies.
- Records. Keep the signed agreement, payment records and any correspondence together.
Unemployment Benefits
Whether a former employee can collect unemployment benefits while receiving severance depends on your state's rules. Don't promise an employee that severance will or won't affect unemployment. Instead, point them to the state unemployment office, and make sure your agreement doesn't try to stop them from applying.
Get Final Pay Right With Updoot
Severance starts with accurate final pay. Updoot's employee time clock records every hour through the last day, and the payroll report gives you a clear summary of final hours, overtime and PTO to hand to your payroll provider.
Sources
- U.S. DOL: Severance Pay
- eCFR: 29 CFR 1625.22, Waivers of Rights and Claims Under the ADEA
- EEOC: Q&A, Understanding Waivers of Discrimination Claims in Employee Severance Agreements
- U.S. DOL: COBRA Continuation Coverage
- IRS: Publication 15, Employer's Tax Guide