It’s Time for Some Spring Cleaning – Give Your Severance Plan a Little TLC
Severance plans assist employers with smoother employee transitions while also providing employees with financial security during what may be a fearful or uncertain time. Done correctly, severance plans reduce employer exposure to employment law issues and help employees with a soft landing. Done incorrectly, what was intended to be a tool to ease tensions can result in heightened anxiety, mistrust, and litigation. To get the best result from your severance plan, it is worth periodically reviewing and updating your plan document and participant communications.
Some items to consider include:
- ERISA plan vs. Non-ERISA payroll practice – Many severance plans intend to be subject to ERISA, which means that state laws are pre-empted and the requirements of a written plan document, reporting (i.e., Form 5500), participant disclosures, and claims procedures apply. Importantly, to be subject to ERISA, the severance plan must be part of an ongoing administrative scheme. A severance plan providing for a single lump sum payment with little employer discretion in determining eligibility and the amount of benefits may not be subject to ERISA, but rather could be considered a payroll practice subject to applicable state law. We are happy to discuss the pros and cons of each structure for your severance plan and discuss which structure might be best for your organization.
- Who is covered – Consider who is intended to be covered under the program, and who will not be covered. It is common to exclude individuals from broad-based severance plans who have separate employment agreements, are subject to collective bargaining, or are part-time or temporary employees. Some employers will maintain separate severance plans to cover different employee groups or groups with different severance benefit levels.
- What situations are covered – The plan document should also address what situations will trigger severance payments (e.g., layoff, involuntary termination, sale of business with no comparable position after the sale), and what situations will not (e.g., termination for cause, comparable job available, voluntary termination).
- Retain flexibility – To reduce the risk of future litigation, employers should retain the right to terminate or amend the plan at any time in their sole discretion. Also, including “Firestone language” that retains discretion for the plan administrator to interpret the plan terms and determine the relevant underlying facts is important to ensuring that thoughtful decisions by the plan administrator receive deference and are upheld by courts if a dispute goes to litigation.
- Follow Plan terms – Following the plan terms, including a reasonable claim process, is important to demonstrate that participants received the benefits they were entitled to and to reduce the risk of courts overturning the decisions of the plan administrator. So, it is critical to make sure that the terms reflect the intended eligibility rules, benefit levels, and plan administration. Also, severance plans may be subject to additional tax laws, such as Internal Revenue Code Section 409A. Failing to follow the terms and requirements of Code Section 409A may result in additional taxes being applied to participants.
- Communicate with Participants – Communicating with participants about the terms of the plan is required for ERISA plans and makes sense so that employees understand the value of the benefit being provided by the employer. Also, communication should help set expectations at a certain level. For example, if the severance plan pays benefits if a participant resigns for “good cause”, which includes a situation of an “assignment to a new position that has a significant reduction in base salary”, it may be beneficial to add additional clarity in the plan or communicate to participants how those terms will be interpreted (e.g., a significant reduction is a permanent reduction of 5% or greater).
A good time to review your severance plan is before it is needed or right after a recent event where lessons may have been learned.
Reach out to your MMM Employee Benefits & Executive Compensation or Employment attorney if you have any questions, or we can help with a review of your severance plan.
