What Is the Difference Between a Settlement & Severance When Losing a Job?

Unexpectedly losing a job is traumatic for most people, and, for some, it can be financially devastating. When you lose your job, though, you are not always left without money or recourse. You might be entitled to either a settlement or a severance package, depending on why you were let go. Understanding the difference between the two can help you get all the money you deserve when you suddenly lose your livelihood.

Employment settlements generally occur when an employee is let go from a job and subsequently makes a claim of wrongdoing against the employer. For example, many employment settlements are reached due to sexual harassment or discrimination cases. With an employment settlement, the employer agrees to meet certain terms for the former employee, usually involving a cash payment of some sort. In most cases, settlements occur out of court with the assistance of attorneys, do not require the employer to officially admit any guilt or wrongdoing and prohibit the employee from seeking any further compensation or taking any legal action against the employer.

Employment severance packages are the compensation provided when you’ve been let go from a job. In some cases, your employment contract or union representation guarantees that you’ll receive some sort of severance. Severance packages vary based on the company, how long you’ve been in your position and the reasons for the dismissal, but they generally include some sort of salary provision, such as a lump sum payment equal to your salary for a specified amount of time, as well as other compensation, such as the continuation of health insurance benefits or keeping your computer. In most cases, when you accept a severance package, you are releasing the company from any sort of claim you have. In other words, if you take the money, you cannot sue the company for wrongful termination or other wrongdoing.

Whether you choose to accept a severance package or seek a settlement depends on your circumstances and the reason for your dismissal. If you’re confident you can prove your company engaged in some sort of wrongdoing – if you believe you were fired because of your race or sex, for example – seeking a settlement may provide you with more money in the long run. Seeking a settlement often requires that you pay some legal fees, and it can take some time to argue and prove your case. If you’re losing your job due to a company sale or merger, downsizing or other reason that is outside the scope of the law, though, taking the severance may be in your best interest.

Both settlements and severances come with financial consequences. In the short term, accepting a settlement package may hinder your ability to get unemployment benefits -- and some severance contracts prohibit you from seeking unemployment. Each state has its own rules regarding how severance packages are handled, but, in most cases, if you qualify for unemployment, your benefits will be delayed due to severance pay. In addition, the money you receive in either scenario is taxable. Depending on how the money in your settlement is allocated, some of the funds may not be taxed, and the tax rates vary. For example, if you receive money for lost wages and attorney’s fees, the wages are taxed, but the fee portion is not. In a severance, the money and benefits you receive are taxed like regular income, and appear on your W-2 at the end of the year.