Severance Pay

Compensation or benefits an employee receives after they leave a company

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What is Severance Pay?

Severance pay is a form of compensation that an employee receives when they are let go by a company. In other words, it is money or benefits that an employer pays an employee who loses their job through no fault of their own. It is frequently required by employment law, but employers may also voluntarily give severance pay even when not required by law to do so. If an employer terminates an employee’s contract for just cause, the employer may not be obligated to provide severance pay.

Severance Pay

The amount of severance pay typically depends on the employee’s length of service and may include stock options, retirement account benefits, payment for unused holiday pay or sick leave, etc. The pay is intended to provide financial protection for the newly unemployed and is typically offered to employees who are laid off or are retiring. It also acts as a safeguard for employees and as a disincentive for employers to let their employees go

How to Qualify for Severance Pay?

Qualifying for severance pay depends on existing regulations. Each country, province, or territory adheres to different rules. In addition, the final amount also depends on the employee’s employment contract, the length of employment with the company, and a union’s collective bargaining agreement (if applicable).

For example, in the province of Ontario, Canada, an employee qualifies for severance pay if:

  1. The employee is severed and they have worked for the employer for five years or more; and
  2. Their employer has a payroll of at least $2.5 million or has severed the employment of 50 or more employees within a six-month period.

When Does Severance Occur?

An employee is considered “severed” when:

  • The employer dismisses or stops employing the employee due to factors such as bankruptcy or insolvency of the company
  • The employer constructively dismisses the employee, and the employee responds by resigning within a reasonable timeframe
  • The employer lays off the employee for 35 or more consecutive weeks
  • The employer lays off the employee due to the business’ permanent closure

How to Calculate the Amount of Severance Pay?

Calculating the amount of severance pay depends on regulations in the respective countries, provinces, and territories. For example:

Ontario Severance Pay

In the province of Ontario, Canada, the maximum amount of severance pay is 26 weeks. The final amount is calculated as follows:

Regular wages for a week x (No. of completed years + No. of completed months / 12 for an employment year that is incomplete)

Severance Pay – British Columbia

In the province of British Columbia, Canada, the maximum amount of severance pay is eight (8) weeks. The total amount is calculated as follows:

  • After three (3) months – One week
  • After 12 months – Two weeks
  • After Three (3) years – One week for each completed year

Sample Calculation

Jennifer has been employed with a car manufacturing company in Ontario for 10 years and 8 months. Recently, due to tariffs on steel and aluminum, the company decides to do a mass layoff to alter its cost structure.

Unfortunately, Jennifer receives notice that she is one of the 500 employees who will be laid off and her exit interview will be conducted in a month’s time. In this situation, under the Employment Standards Act, Jennifer is entitled to severance pay.

Assume that Jennifer makes $25 an hour and works 40 hours a week. A week’s wage for Jennifer would be $1,000. The amount of severance pay Jennifer is entitled to would be:

$1,000 x (10 + 10/12) = $10,833.33

Had Jennifer been employed in British Columbia, the amount of severance pay she is entitled to would be:

$1,000 x 8 = $8,000

Note: The maximum amount of severance pay in British Columbia is 8 weeks.

Thank you for reading CFI’s guide to severance pay. CFI offers the  Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:

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