Is Your Severance Plan Subject to ERISA? A Complete Guide for Employers
Most severance plans are subject to ERISA if they involve ongoing administration or employer discretion. Simple, one-time payments typically are not.
Severance plans are often treated as routine HR processes—but legally, they can carry significant complexity. That’s why this is one of the most important (and commonly misunderstood) questions.
Is your severance plan subject to ERISA?
Employers should make sure they know the answer to this question. Severance plans that are ERISA eligible must fulfill the legal requirements for reporting and disclosure, fiduciary responsibility and administration, as well as enforcement, alongside other federal and state severance laws.
In this article, we’ll break down:
What ERISA is
When severance plans fall under ERISA
Key legal tests and examples
The advantages of ERISA-covered plans
Employer compliance requirements
What Is ERISA and How Does It Apply to Severance Plans?
The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that governs employer-provided benefits plans. ERISA protects employees by ensuring that benefits are managed responsibly and that plan participants understand their coverage and rights.
Here are five ways ERISA protects employees:
Requires plans to provide detailed plan information, including features and funding;
Establishes fiduciary responsibilities for those who manage and control plans;
Requires plans to have a grievance and appeals process;
Gives participants the right to sue for benefits and breaches of fiduciary duty; and
Prohibits employers from retaliating against employees who exercise their rights under an ERISA-qualifying plan.
ERISA often comes up in the context of health and retirement plans, but employers need to understand how ERISA applies to severance.
Are Severance Plans Subject to ERISA?
Generally speaking, any plan that regularly provides severance benefits is considered an ERISA welfare plan. This is true regardless of whether the plan is documented in writing. If an employer regularly pays severance benefits to terminated employees, the practice is most likely classified as an ERISA welfare plan.
Now, let’s take a look at some of the legal background ERISA’s application to severance plans. In Fort Halifax Packing Co., Inc. v. Coyne, 482 U.S. 1 (1987), the U.S. Supreme Court held that severance plans that “necessitate an ongoing administrative scheme” are subject to ERISA.
So, what constitutes an “ongoing administrative scheme” when it comes to severance management? If the plan is very straightforward and doesn’t involve significant employer discretion and administration, then it’s probably not subject to ERISA. For example, in the Fort Halifax case, the employer provided a one-time, lump-sum severance payment triggered by a plant closing, which was not considered an ongoing administrative scheme since it was akin to a simple payroll practice.
Here are some factors that make a severance plan more likely to be an “ongoing administrative scheme” and therefore subject to ERISA:
The company has the discretion to determine eligibility and/or available benefits;
The benefits require ongoing coordination and/or control;
The company calculates benefits based on individual factors, like tenure or performance; and/or
Payments are made over time and/or include additional benefits (e.g., outplacement services).
In short, more employer discretion = more likely to be an ERISA plan.
Welfare vs. Pension Plans
In some cases, severance plans may also qualify as pension plans. That happens if the following criteria are true:
The severance plan is directly or indirectly tied to an employee’s retirement;
The plan pays more than two times the employee’s annual compensation during the last full year of work; and
The severance payments extend beyond 24 months after the employee’s departure.
In the situation above, employers must also ensure they follow ERISA’s funding and vesting requirements.
The Advantages of ERISA-Covered Severance Plans
Although ERISA might sound like yet another level of bureaucracy, it provides employers with significant protection. Here are four ways an ERISA severance plan can be advantageous to employers.
1 – Maintain Employer Discretion
ERISA-covered severance plans can be written in a way that provide employers broad discretion as plan administrators. This enables employers to have more flexibility in interpretation and plan management, which tends to hold up in court. Some employers even choose to document severance benefits as best practices, noting that benefits can change with or without notice.
2 - Consistent Application of Severance Policies
Employers can mitigate risk by formalizing their severance practices. With thoroughly documented severance plans, employers can consistently apply policies across the organization, leading to more equitable employee treatment. Severance policy details may include eligibility criteria, severance pay formulas, exclusions, and more. Lack of documentation can open employers up to potential disputes.
3 - Formal Dispute Process
ERISA plans must have a formalized claims and appeals process. Although this requires additional administrative work from the employer, it also means employees must follow specific steps to raise claims. ERISA’s grievance procedure includes a thorough pre-litigation administrative process, potentially reducing the number of lawsuits filed.
4 - Preemption of Federal Law
Since ERISA is a federal law, employees must file severance-related claims in federal court, which tends to yield more favorable results for employers. ERISA lawsuits generally don’t allow for punitive damages, meaning employees are often limited to recovering any benefits they were denied, helping ensure proper plan administration. Additionally, ERISA lawsuits are heard by judges rather than juries, creating more financial predictability.
4 Key ERISA Requirements for Employers
When a benefits plan is subject to ERISA, employers must do the following:
Provide a plan description to employees, outlining how the plan works;
File an annual report (Form 5500) detailing how the plan is being managed and its financial status;
Prevent discrimination, meaning you can't offer better benefits to certain employees based on individual factors; and
Establish a claims and appeals process so employees can question benefits-related decisions, providing fairness and transparency if claims are denied.
Even better, employers can proactively design their severance plans with ERISA compliance in mind. This helps ensure your organization is getting the most benefit from an ERISA-covered plan.
Ready to Simplify Severance?
Severance packages help ease the stress of job loss for employees, but for HR teams, the process is particularly complex. With configurable severance automation tools—including a built-in calculator—Onwards HR’s specialized offboarding technology helps employers streamline severance in compliance with corporate policy and employment laws.
No matter the specifics of your severance plan, or whether it’s subject to ERISA, Onwards HR can be customized to ensure rules are consistently applied based on the intricacies of your severance policies. Multiple severance plans? Not a problem.
Severance doesn’t have to be so complicated. Request a demo today.
