More than 60,000 Kansas City residents were unemployed in August 2014, a number which is likely to increase due to the recent workforce reduction plan announced at Sprint Corp., leaving some community members facing life and career transitions. Many employees have seen their companies face the possibility of layoffs over the past several years, and for those whose jobs are eliminated, the parting offer of severance pay may help ease the transition.
What is Severance Pay?
Typically, severance pay is a form of compensation to employees who have been laid off or had their position eliminated, though it may also include payment to employees who leave the company for other reasons. Severance packages could be used to reward the loyalty of long-term employees, or reduce the possibility of backlash that may accompany a termination.
Companies do not have to offer severance pay unless certain state laws, union agreements or employer contracts require it, so it is generally seen as a voluntary offer of payment.
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Packages may include a lump sum or periodic payments related to length of employment, continued insurance and benefits, outplacement services or any other benefit agreed upon by the company and the departing employee.
To accept severance pay, employees are usually asked to sign a release from claims meant to help the employer avoid potential future lawsuits. There may be other requirements stated in a release, so it is helpful to read them over carefully and speak to someone with experience in severance packages, if necessary.
For many employees, seeking legal advice on a severance package may not be cost-effective, but for high-ranking employees or those with non-compete or other legal issues, it doesn’t hurt to make sure you are protected.
The Financial Considerations
If given the option to take a lump sum severance payment or periodic payments, there are factors to consider which may affect your decision.
Ask yourself these questions: Do I need the funds immediately or do I have other income sources to help meet my cash flow needs? What tax consequences would I face if I take a lump sum payment? Does my state view the periodic salary continuation payments as income which might affect my unemployment eligibility? Does my state consider the value of my lump sum payment in determining when I’m eligible for unemployment? Do I need health insurance? How long until I qualify for my retirement benefits?
Understanding your needs and options before making a decision could be helpful as your decision will likely impact your financial future.
What about My Pension Options?
If you’ve been given the option of a pension payout strategy when you leave your employer, you may also face the lump sum vs. continual payment debate. Some of the questions you should consider regarding severance pay options also hold true in this situation, but other issues come into play here. Situations where a lump sum may make sense would be when you face poor health and have a short life expectancy or you already have a secure nest egg to meet your income needs. When you choose to take lifetime payments, you are assured the money will continue to come in throughout your lifetime, but the payments usually stop upon your death and are not passed on to survivors.
If you work with a financial advisor, they can help you determine your financial needs compared to the severance package or pension payout options offered. If you do not have an advisor or did not consult them while making your decision, you should let them know which options you chose so they can help you make any necessary adjustments to your financial plan.
Marc C. Shaffer, CFP®, AIF®, EA, is a principal of Searcy Financial Services Inc., a registered investment advisory and financial planning firm located in Overland Park. He currently serves as Chairman of the Board for the Financial Planning Association of Greater Kansas City. For additional information, visit www.SearcyFinancial.com.