How Does Severance Pay Work vs. Unemployment Benefits?

If you lose a job through no fault of your own -- for instance, if a business closes or decides to lay off workers and you’re one of those who is suddenly out of work -- you may be able to collect unemployment benefits. With a few exceptions, employers pay unemployment insurance for their employees, and this entitles you to a payment each week while you look for a new job. Though the federal government established unemployment benefits back in the 1930s, each state makes its own rules about how much they’ll pay and when. If you earn any money while you’re looking for a new job, this can reduce the amount of your benefit check for that week. If your former employer pays you a lump sum when you leave your old job -- known as severance pay -- this may also affect your unemployment benefit.

As soon as you’re laid off or leave your old job, you should contact your local unemployment office to file a claim. The benefits counselors will look at your work history -- how much you’ve earned over the past year to 15 months. They’ll take an average of this amount, using a formula that varies from state to state. You’ll receive a percentage of this amount each week you’re unemployed for up to 26 weeks in most states. When you find a new job, benefits stop. If you take part-time or temporary work, the amount you earn will reduce or temporarily halt your unemployment benefit. Every week, you’re required to file a new claim and report any money you’ve earned, as well as where you’ve looked for new work.

Severance pay, also known as separation pay or termination pay, is an employer's voluntary offer of payment to an employee who has been terminated or whose job has been eliminated, according to AARP. Not every employer offers severance pay, but when they do, it may be in the form of a set amount, or a payment for each year you’ve worked for the employer. Sometimes, the employer will pay you over several weeks, instead of issuing a lump sum. However much you receive in severance pay, you must report the money on your unemployment claim form. Different states treat severance pay differently when figuring how much you’ll receive on your unemployment benefit check.

Since every state gets to make its own rules about unemployment benefits, you have to follow the rules for your state. Michigan treats severance pay like income and depending on the amount of severance pay, a worker's unemployment benefits can be affected in various ways. For example, the Michigan Department of Licensing and Regulatory Affairs reports that if the severance equals 1.6 or more times the unemployment benefit check you’re entitled to, you don’t receive a check that week. In general, however, the severance pay only reduces your unemployment benefit check for the week in which you received your severance pay.

Other states, such as California, don’t reduce your unemployment because you’re receiving or have received severance pay. You still have to report the money to the unemployment commission, but it doesn’t affect your unemployment benefit. But the pay must be termed separation or termination pay. Vacation pay and “payment in lieu of notice” may be treated differently. Again, it depends on the rules in the state where you’re filing for benefits. Unemployment counselors can explain the rules to you and help you figure out how much unemployment benefits you’ll receive.