Separation and Severance: Understanding Your Options as an Employer

May 6, 2020 Samantha Blattler

The COVID-19 pandemic has changed a lot of things about the way businesses operate: from implementing work-at-home solutions to practicing telemedicine in the healthcare space, reorganizing shift work hours, implementing social distancing policies, and in many cases, downsizing the workforce.

In some businesses, layoffs occur on a regular basis at a certain predictable volume. For others, workforce reductions are much less common and result from large-scale shifts precipitated by a crisis (such as the one we’re in), M&A activity, or a major change in a company’s strategic direction. Whatever the reason, letting go of employees is never an easy or simple decision. That is one of the reasons employers in the United States, since the days of the Civil War, have offered employees severance pay.

So, what do employers need to know about severance in 2020 — and how can you make the best decisions for both your outgoing employees and the future of your business?

Two common two types of severance plans

For employers, it is critical to understand the options you have when it comes to severance plans. Many employers offer traditional severance plans (#1 below), but in this blog, we’ll explore the differences and benefits afforded by the second type of plan: the Supplemental unemployment Benefit (SUB) plan.

1. Traditional severance plan

The traditional severance plan, funded through an employer’s general assets or from a trust fund, evolved from the U.S. labor code in the 19th century. During the Civil War, a severance equal to three months of pay was given to soldiers upon discharge. This led to extending severance payments to workers in many situations. By the end of World War II, new legislation resulted in a proliferation of employer-sponsored severance plans.

2. Supplemental Unemployment Benefit (SUB) plan

SUB plans were introduced in 1955. These plans were often used in union negotiations to guarantee wages during periods of unemployment. SUB plans provided additional payments by the company over and above state unemployment benefits and were not subject to Federal Insurance Contributions Act (FICA) taxes (that is, Social Security and Medicare payroll taxes). The use of SUB plans has spread across industries as they allow employers to realize significant savings while still providing a 100% replacement of base pay during the employee’s period of severance.

How does a SUB plan work?

A SUB plan works in many ways like state unemployment benefits:

  1. Employees must register and be eligible for state unemployment in order to receive benefits from the SUB plan.
  2. Each week, terminated employees must verify that they are still unemployed and physically capable to work as defined by their state unemployment agency. This is often done via a website or interactive voice response system (IVR).
  3. Payments must be made on a weekly or payroll-by-payroll frequency and are based on the employee’s base pay, excluding any overtime or bonus pay.
  4. During the period of unemployment, SUB plan benefits (unlike traditional severance plan benefits) are not subject to FICA taxes. This saves the employer and the employee up to 7.65% in taxes. If the terminated employee becomes reemployed, any future payments become subject to FICA taxes.
  5. Payments from a SUB plan for most states can be paid concurrent with the terminated employee receiving his or her state unemployment benefit.

Sizing up the tax benefits for employers and employees

The elimination of FICA taxes brings financial advantages to both the employer and the employee.

Take an example of one employee who is laid off and has a benefit of $1,000 a week for 26 weeks. If the employee verifies his unemployment status each week and does not find a job within the 26-week period, he would receive $26,000 over the period of his SUB plan payments. If the same payments were made from a traditional severance plan, assuming a FICA rate of 6.20% and Medicare tax rate of 1.45%, he would receive $24,011. That’s $1,989 less that he would have been paid under the traditional severance plan!

The employer pays $1,989 less in taxes as well. Therefore, by using a SUB plan, the employer has lowered its severance spending while simultaneously increasing the benefit paid to the employee. For employers, the savings can really add up when you’re managing multiple layoffs or if your operations require any sort of regular or ongoing reductions.

How to adopt a SUB plan

If you’re considering a SUB plan for your business, it’s crucial that you have expertise in plan design, regulations and administration. This is mission critical because SUB plans are Employee Retirement Income Security Act (ERISA) plans and require plan documents, summary plan descriptions, approval and filing in various states and annual IRS filings. Each state has its own rules regarding the application of SUB plans and integration with state unemployment.

Much like retirement plan administration, communications require personalized packets educating the terminated employees on the SUB plan requirements for that individual. In addition, kits that include step-by-step instructions for employees are needed to simplify the plan administration. Employees need a method to report their employment status on a weekly basis. A service center to assist employees with questions, resolve reporting errors and reach out to employees who fail to report their employment status is essential to administering the plan.

As with all benefit plans, data must be clean and automated to ensure it is reported correctly. Employment status monitoring and payroll feeds need to be 100% accurate so that severance payroll is correct.

Investigating severance plan options? Conduent can help.

Managing separation and severance is never easy, but it’s wise to fully understand the options available to you as an employer — and for your employees as well. It is possible to maximize your severance benefit plans and control your costs while fulfilling your promises to terminated employees.

When deciding whether to adopt (or stick with) a traditional severance plan or convert to a SUB plan, there’s a lot to consider. We will explore those options more in our next blog. In the meantime, if you’d like to talk more about your severance plan administration needs or how to set up a SUB plan, Conduent can help.

Learn more here or contact us today.

About the Author

Samantha Blattler is a Manager of Technical Business Analysis for Conduent's Kinetic Application Technology (KAT) and Severance Solution team.She manages the implementation, ongoing administration and processing of customized web-based technology solutions for HR administrators and employee users, with emphasis in support and enhancement of HR functionality and employee engagement. Solutions include administration systems, interactive retirement modeling, non-qualified plan enrollment and modeling, pension choice/change modeling and decision support tools.

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