Severance Agreement: What Employers Need to Know

A severance agreement is a contract. In exchange for severance pay and other benefits, the departing employee releases legal claims against the company. Done correctly, it provides real protection. Done incorrectly, it may be unenforceable at exactly the moment you need it most. This overview covers the essential elements, the legal requirements you cannot skip and the provisions that commonly get companies into trouble.

Important note before you proceed

Severance agreements, particularly those that include a release of age discrimination claims under the ADEA (Age Discrimination in Employment Act), are subject to specific legal requirements that this template cannot fully address. If the departing employee is 40 or older, or if you are conducting a reduction in force affecting multiple employees, you must involve legal counsel before presenting any agreement. The cost of getting this wrong is significantly higher than the cost of a one-hour attorney review.

When to offer severance

There is no federal law requiring severance pay in most circumstances. Severance is a business decision, but it is a consequential one. Offering severance in exchange for a release makes sense when: the separation carries any legal risk (disputed termination, discrimination claim history, whistleblower activity); the departing employee has significant institutional knowledge and you want an amicable transition; the termination is a layoff or reduction in force and you want to protect against WARN Act or related claims; or your employment agreement, handbook or offer letter has created a severance expectation. Do not offer severance routinely without a release. Severance without a release is just a gift.

Core elements of a severance agreement

Every severance agreement should include: (1) Identification of the parties: full legal names of the employee and employer entity. (2) Separation date: the specific last day of employment. (3) Severance payment terms: the amount, the payment schedule (lump sum or installments) and the timing. (4) Benefits continuation: whether COBRA will be paid, for how long and under what conditions. (5) Release of claims: the scope of what the employee is releasing, which should be as broad as the law allows in your jurisdiction. (6) Return of company property: a specific obligation to return all company equipment, documents and materials by the separation date. (7) Non-disparagement: mutual or one-way, and what it covers. (8) Confidentiality: protection of the agreement terms and often of company information. (9) Cooperation: obligation to assist with transition, litigation or regulatory matters. (10) Governing law: which state's law governs.

ADEA requirements for employees 40 and older

If the departing employee is 40 or older, the Older Workers Benefit Protection Act (OWBPA) imposes specific requirements or the release of age discrimination claims is void. The agreement must: explicitly reference the Age Discrimination in Employment Act; advise the employee in writing to consult an attorney; provide the employee at least 21 days to consider the agreement (45 days if part of a group layoff); allow the employee 7 days to revoke the agreement after signing; and, in group layoffs, provide a list of all employees offered the agreement and those not offered it, with ages and job titles. Do not present a severance agreement to a 40+ employee without these provisions. An unenforceable release of ADEA claims is the most common reason severance agreements fail.

What a severance agreement cannot release

Even a broad release cannot waive certain claims. These include: workers' compensation claims for injuries that have already occurred; claims for unpaid wages (in most states, a separate wage claim release is required); EEOC charges or participation in government investigations; vested retirement benefits under ERISA; future claims arising after the agreement is signed; and in some states, claims for unemployment insurance. Your release language should not attempt to waive these claims. Doing so can make the entire release voidable.

Separation agreement vs. severance agreement

These terms are often used interchangeably, but they have different emphases. A separation agreement focuses on the mechanics of the departure: final paycheck timing, property return, references and the separation date. A severance agreement adds the release of claims in exchange for additional consideration. You may use both, or a single combined document. The release language is what requires the most care.

Non-compete and non-solicitation in severance

Including non-compete or expanded non-solicitation provisions in a severance agreement is a business decision with significant enforceability variation by state. California, Minnesota, North Dakota and Oklahoma have near-total bans on post-employment non-competes. The FTC's 2024 rule attempting to ban most non-competes has been subject to ongoing litigation. Before including any post-employment restriction, confirm current enforceability in the employee's state of work. Unenforceable restrictions in a severance agreement do not automatically void the rest of the agreement, but they can create disputes.

Reference policy and what to say

Align the severance agreement with your company's reference policy. If you provide only title and dates of employment as a standard practice, say so in the agreement. If you are willing to provide a neutral or positive reference, commit to that in writing and ensure the manager who will receive calls is aware. A departing employee who receives a severance agreement promising a neutral reference and then gets a negative one has a retaliation or contract claim. Coordinate with HR and the manager before making any reference commitment.

Payment and tax treatment

Severance payments are generally subject to federal income tax withholding, FICA and state income tax. A lump sum payment in the final paycheck may push the employee into a higher withholding bracket. Consider offering installment payments if the amount is large. Payments made in settlement of a discrimination claim may have different tax treatment depending on how the settlement allocates the payment. Do not promise the employee that severance payments are tax-free without confirming it with a tax advisor. That is a commitment you cannot make.

What to do with this overview

Use this as a checklist and education tool, not as a template you populate yourself for high-stakes separations. For routine separations of employees under 40 with no legal risk indicators, your HR partner can often prepare a standard agreement. For any termination involving an employee 40 or older, a group reduction in force, any prior complaint, charge or litigation, a role with access to significant confidential information, or an employment agreement with specific termination provisions, get legal counsel involved before the agreement is prepared or presented.

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