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Understanding Severance Pay Laws: Your Rights as an Employee

9 minutes

Severance payment is an essential element of employment law, which gives some financial support to employees who are laid off or terminated. Being aware of India’s severance pay laws is important for both employees and employers, to manage equitable and legal procedures. This blog gives a thorough understanding of what constitutes severance pay across different parameters like definition, calculation, policies, and legal framework in India.

What Is Severance Pay?

Severance pay is a type of compensation provided to employees upon dismissal from work. It assists in financial terms during the unemployment stage. Severance pay usually comes up when staff are laid off, made redundant, or mutual agreement terminations. The main aim behind this is to provide some money for the survival of the employees as they search for other opportunities.

Severance pay can include various components such as salary, bonuses, accrued vacation, and other benefits. The amount and duration of severance pay depend on several factors, including the employee's length of service, company policy, and the circumstances of termination.

Legal Framework Governing Severance Pay in India

The Industrial Disputes Act 1947 and the Payment of Gratuity Act 1972 are the principal laws that regulate severance pay in India. These statutes ensure fair compensation made to employees when their employment contracts is terminated. Understanding these legal provisions is important for employees and employers alike, to ensure compliance and avoid disputes.

Industrial Disputes Act, 1947

The Industrial Disputes Act, of 1947 provides the guidelines for the payment of layoff compensation and retrenchment compensation provisions. Provided there has been continuous service for at least twelve months, employees in case of retrenchment are eligible for severance pay. In this Act, retrenchment refers to the termination of employment on grounds other than ill health, disciplinary action, and retirement.

Payment of Gratuity Act, 1972

Gratuity is paid to an employee after they have completed five years in service according to The Payment of Gratuity Act (1972). Employees are often given gratuity as a way of thanking them through a lump sum payment made to them. Even though it does not fall specifically under such headings as severance pay; it is an integral part of the entire compensation package meant for terminated employees.

Severance Pay Calculation

In India, the calculating severance pay can vary depending on the type of company concerned such as public sector undertakings, private companies, and multinationals. Here is a summary of how gratuity is generally computed for each type of company:

1. Public Sector Undertakings (PSUs):

Severance benefits in PSUs are usually better than those for private sector workers because they tend to have higher job security. The severance pay calculations in PSUs, follow guidelines laid down by the Industrial Disputes Act, of 1947, or specific PSU policies which usually offer a more generous calculation formulae. The formula typically used in PSUs is:

Severance Pay = (Last drawn salary) × (Number of years of service)

  • This formula may include full salary or basic wage components, depending on specific PSU policies or applicable laws.

2. Private Companies:

In private companies, severance pay is less regulated and can vary greatly depending on the company's policy. However, the minimum standard remains governed by the Industrial Disputes Act, which mandates a severance pay equivalent to 15 days of the last drawn salary for each completed year of service. Private companies may choose to offer more than this minimum to maintain competitive benefits or adhere to internal policies. The actual calculation can be influenced by the employee’s role, tenure, and the terms stated in their employment contract. The standard formula under this act is:

Severance Pay = (Last drawn basic salary + dearness allowance) × (15 days’ worth of salary) × (Number of years of service)

  • This calculation is based on the last drawn basic salary and dearness allowance for each completed year of service.

3. Multinational Corporations (MNCs):

Multinational corporations may have their own global severance policies but must adhere to local laws. They often include various compensation components in the severance calculation, making it more comprehensive:

Severance Pay = [(Last drawn salary + bonuses + other compensations) / 30 or 26 days (depending on the policy)] × (15 or more days’ worth of salary) × (Number of years of service)

  • This formula can be adapted based on the company's internal global severance policy but usually provides a calculation that considers the total remuneration package.

Additional Considerations:

  • Bonuses and Variable Pay: In certain organizations, for instance, MNCs, the calculation of severance benefits may include bonuses and variable pay as well, thus raising the total amount considerably.
  • Company-Specific Policies: To be competitive and improve staff satisfaction some companies may offer more than the statutory minimum when it comes to severance packages. This is especially common in industries that face stiff competition for highly skilled employees.

Factors Influencing Severance Pay

Several factors influence the amount and structure of severance pay. These factors include:

  1. Length of Employment; How long the employee has served the organization is an important element in calculating severance pay. In most cases, employees with longer period of service are given higher severance payments since they are being appreciated for their long service to the company.
  2. Company Policy: Every company may develop its policy on severance pay which contains specific provisions for compensation when terminating workers. The latter can also be found in employee handbooks or employment contracts.
  3. Grounds for Termination: The reason why an employee was terminated is an additional factor that affects his/her severance pay. For instance, staff who were laid off because of economic downturns or restructuring may get other types of severance packages unlike those dismissed due to disciplinary issues.
  4. Collective Bargaining Agreements: Sometimes, collective bargaining can influence the amount that a person receives as his/her severance pay from his employer. Frequently, these coverages lay out conditions and payments linked to dismissals among unionized members.

Severance Pay Policy

A severance pay policy is a document describing organizational ways of giving terminated employees their severance pay. Equally important, the policy serves as the guide for both parties involved to ensure fairness and consistency.

In India, the standard way of calculating severance package is on the salary last drawn by an employee before termination of employment and the length of time they worked with the company. Usually, the value paid in this case is equal to 15 days of average pay for every year that has been fully served. However, an employer may offer above this minimum if his or her company has such intentions but cannot legally provide anything less than that.

Key Elements of a Severance Pay Policy

A comprehensive severance pay policy should include the following elements:

  1. Eligibility Criteria: The policy must specify the conditions for which the employees will be qualified for getting their severance pay. These may contain the minimum duration of service and terminations that are eligible for severance pay.
  2. Calculation Method: A severance pay calculation methodology should be described in a policy, if any such calculative processes exist, including such additional elements as bonuses or accrued vacations.
  3. Payment Schedule: The policy must describe when employees will actually get their severance pay and therefore it should have a timeframe specifying these dates.
  4. Extra advantages: The policy might include other benefits like extended health coverage, outplacement services or help in finding a job among others besides severance pay.
  5. Legal Compliance: The policy should ensure compliance with relevant labor laws and regulations, including the Industrial Disputes Act, of 1947, and the Payment of Gratuity Act, of 1972.

Employee Rights and Employer Obligations

For fair and legal pay practices when discharging employees, it is important to understand the roles of workers and employers.

Employees have a right to be paid severance benefits as stipulated under their employment agreement and firm’s policy. The employee has a right to know how severance payment is calculated, payout dates, and other extra benefits he/she should expect from his/her employer.

The employers are obliged to compensate the dismissed employees by using the company’s severance pay policy as well as applicable labor laws. They must make sure that they have accurately calculated severance pay and disbursed within the stated time frame. Also, there is a requirement for companies to notify workers about what constitutes their redundancy payments clearly.

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Best Practices for Employers

Employers can adopt several best practices to ensure fair and transparent severance pay practices:

  1. Clear Communication: Employers must be clear about the severance benefits policy to all staff members and make sure they provide more details concerning who can qualify, how it is calculated, payment schedule, and additional benefits.
  2. Consistency: Failure to apply the procedure of giving severance packages uniformly to every eligible employee may give room for thinking that some are favored over others based on job status or ethnic background.
  3. Documentation: There should be appropriate record-keeping regarding calculations and payments made to compensation for dismissal from service. These records come in handy during disputes or audits.
  4. Legal Compliance: Employers need to be very careful that their severance payment practices follow the labor law and regulations. A routine audit or review of the severance pay policy can identify compliance issues.
  5. Support Services: Employers may also offer other support services for terminated employees such as outplacement services, job search help, and counseling. These services can ease employee transition into other employment opportunities.


For both workers and employers in India, it is necessary to understand the rules and regulations governing severance pay. It provides financial support for those who are jobless and ensures fair treatment in case of termination. By following the legal framework and applying transparent as well as consistent practices on severance packages, employers can contribute to a positive work environment leading to good employee relations.

Employees need to know their rights concerning severance pay and should seek assistance whenever they feel that these rights have been violated. Employers should give priority to clear communication, compliance with the law, and welfare services that promote fair and transparent practices concerning retrenchment benefits. In so doing, both sides can be able to handle the intricacies of a retrenchment package confidently with fairness.

Frequently Asked Questions

  1. What is Severance Pay?

Severance pay refers to the monetary compensation given to employees who have been terminated under certain circumstances like a layoff or business closure which are not due to personal fault.

  1. How do we calculate severance pay in India?

Under Indian law, the usual method of calculating severance pay as per the Industrial Disputes Act 1947 is based on a worker’s final basic salary plus dearness allowance multiplying this sum by 15 days' worth of salary for every year of completed service.

  1. What influence affects the Company’s Severance Pay Policy?

The type of the firm (public, private, MNC), individual employment contracts, company-specific policies as well as necessary legal requirements can also affect a company’s severance pay policy.

  1. Can severance pay be negotiated in India?

Yes. Sometimes an employee can be able to negotiate their severance pay where especially when this mostly happens in private companies and MNCs. The amount is often higher than the statutory minimum determined by factors such as the employee’s bargaining power, terms of employment contract, and employer’s policies.

  1. What is the minimum severance pay an employee is entitled to under Indian law?

Under Indian law, particularly according to the Industrial Disputes Act, the minimum severance pay is typically calculated as 15 days of the last drawn basic salary plus dearness allowance for each completed year of service, applicable to employees who have been in service for at least one year.


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