Separation and severance: How to understand your options as an employer

For some businesses, layoffs occur on a regular basis at a certain predictable volume, such as within a seasonal retail operation. For others, workforce reductions are much less common and result from large-scale shifts caused by an external event such as an economic recession, the COVID-19 pandemic, merger and acquisition activity, or a major change in a company’s strategic direction. 

Letting go of employees is never an easy or simple decision. That is one of the reasons, since the days of the Civil War, U.S. employers have offered severance pay to employees. As an employer, here’s what you need to know about severance right now — and how can you make the best decisions for both your outgoing employees and the future of your business.

Two common types of severance plans

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 post, we’ll explore the differences and benefits afforded by the second type of plan: the Supplemental Unemployment Benefit (SUB) plan (#2 below).

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 other industries. 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, introduced in 1955, 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 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 of 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. In most states, a terminated employee can receive payments from a SUB plan concurrently with state unemployment benefits, which is uncommon for traditional severance plan benefits. This provides additional assistance to the employee, bridging the gap to future employment.

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 the example of one employee who is laid off and has a benefit of $1,000 a week for 20 weeks. If the employee verifies her unemployment status each week and does not find a job within the 20-week period, she will receive $20,000 over the period of her 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%, she would receive $18,470. That’s $1,530 less than she would have been paid under the traditional severance plan!

The employer pays $1,530 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. The step-by-step instructions for employees simplify their role and aid in smooth plan administration.

Terminated employees need a method to report their employment status on a weekly basis. A service center to assist terminated employees with questions, resolve reporting errors and reach out to those 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. If you’d like to talk more about your severance plan administration needs or how to set up a SUB plan, our experts are available. Check out our webinar for more information about these options and read a real-life case study here.

Learn more here or contact us today.