April 04, 2024
Benefit Issues to Watch For When Employees Leave
What happens to benefits comes up a lot in layoffs or other terminations where the employer offers severance. It's also an issue in executive and other management contracts about what happens when the executive resigns or is requested to.
And it gets complicated fast. I try my best to hide and run away from anything involving tax issues or ERISA, but compensation and benefits always do.
Health insurance is a great example. If the employer keeps the employee on the payroll for the severance period and remains an employee, the employer can continue the benefits as though the employee was still working. If the employee is terminated and is no longer an employee, the employer is free to reimburse the employee for their share of COBRA or a set amount if they want to shop around on their state exchange.
Other really common issues are how employer retirement funds are handled, stock options, and payments of bonuses and commissions that are earned before termination but paid after. These depend on a combination of law and the contracts related to each program.
This article is a great resource on both the issues and how to approach them when you're dealing with layoffs or terminations and benefits.
No matter the size of your organization, at some point in time employees leave. As we noted previously, it behooves human resources and other departments to provide departing employees with an exit letter that includes important dates, deadlines, and reminders. In addition, watch out for the items below and consider including one or more of them as part of any exit letter or severance agreement (especially for departing officers and senior management).
No, that isn’t a typo, so what does it mean? In general, there are two kinds of post-employment pay given to former employees: (1) severance pay, which doesn’t relate to payment for services rendered and wouldn’t have been paid if employment had continued, and (2) post-termination pay, which is pay or benefits that would have been paid or received if employment had continued, such as a final paycheck or vacation cash out, in either case, paid after termination. Some advisors call severance “go-away pay,” and it never counts as compensation for 401(k) contributions. Post-termination pay, however, is fact dependent and you need to read the definitions and terms of your 401(k) plan to know whether it includes such pay (compensation); if it’s included, then a timing requirement will also apply, such as two and a half months after separation, so you will need to know or have a good idea of when the post-termination payments will occur.
When deciding what post-termination benefits to provide or ask for, we recommend first reviewing any existing employment agreement or other governing contract. (In addition to employment agreements, employees may have other contracts or plans that need reviewing, such as equity awards, supplemental executive retirement plans, and non-compete agreements, which are discussed below.) Whether recently enacted or several years old, governing contracts provide the starting point not only for what’s legally required but also for how negotiations may proceed. Something that was much sought after or bargained for in the past may no longer have such swaying power. The parties may negotiate to provide something different than what’s in the governing contract, but savvy employers will not only review all agreements first they will also carefully draft and include a merger clause in the severance agreement, basically providing that the severance agreement is the controlling document for severance benefits and that it specifically overrides any former agreements or contracts.
Notwithstanding the general rule about negotiation, everyone should pay extra attention to Internal Revenue Code Section 409A (409A) issues if the form or timing of payments changes between what was required under the original contract and what’s provided under the severance agreement. While heavily fact-specific, certain changes may result in immediate taxation and an additional 20% excise tax under 409A, a situation nobody wants. For example, an employment agreement may provide a cash severance payment equal to two years of base salary payable over twenty-four months beginning 60 days after termination. Whether those payments can be accelerated into a lump sum payment payable 60 days after termination depends on additional facts and more specifics of the original agreement. You want to seek someone with a solid understanding of 409A and its many intricacies before changing the time and form of any payments previously agreed to.
While welfare benefits can be many and varied, three post-termination benefits often asked about include subsidized COBRA benefits, group life insurance, and long-term disability. They’re nuanced and contain enough traps to warrant further discussion.
As we’ve talked about before, it’s typical for many employers to subsidize the cost of COBRA continuation for terminating employees, often providing that the person will be responsible only for paying active employee rates during all or some portion of the standard 18-month COBRA period. Those wishing to offer this benefit should remember the following:
Employers wanting to avoid challenging situations may decide against promising any ongoing life insurance benefit post-termination. Instead, better practice calls for noting in the separation agreement or other writing to the employee about the right to convert the group life insurance coverage to an individual policy. Alternatives exist, such as obtaining a one-person policy through an insurance company, but those quickly become challenging situations because of the cost and administrative work involved. If the soon-to-be former employee pushes for the benefit, a compromise may be increased severance, which would be taxable to the individual but far easier for the employer to administer because it becomes the individual’s responsibility to find a replacement for that benefit.
Generally, companies should avoid making any promises to provide long-term disability beyond termination (except as may otherwise be covered under the employer’s long-term disability policy), whether that’s done with explicit language or with global references to employer benefits. Promises or inferences otherwise may lead to the employer providing the benefit out of its own coffers, because insurance coverage will end for the departing employee, leaving the employer on the hook, and means the employer then administers a benefit that should generally only apply for actual employees, with unknown or very uncertain terms. Instead, employers would do well to specifically mention when such coverage will end, cross-referencing the applicable plans and policies.
Sometimes employment contracts have non-competes built in, sometimes they are separate agreements, and sometimes they are included as part of the separation agreement or otherwise entered into at termination. Regardless of how they come about, they have been a hot topic of legislation and litigation for the past several years. If you want to rely on them for current or future use, we encourage you to work with trusted counsel and remember:
The number of states and other localities that prohibit or heavily regulate non-competes and similar restrictive covenants is significant and ever-changing, so a document or information you relied on even one year ago deserves review and possible revision. In addition, states that allow non-competes often do so with caveats and contingencies, such as imposing income thresholds prohibiting non-competes for low-earning employees, as our labor and employment colleagues have discussed, further proving that the world of non-competes remains fluid and open for discussion.
Sometimes employers will add or rely on non-competes they know or suspect are legally unenforceable or overbroad, with the idea being maybe its presence alone will deter someone from competing. As our colleagues have noted previously, this “what’s the harm in trying” approach can lead to civil (and sometimes criminal) penalties for improper enforcement of non-competes, with nine states as of July 2023 imposing such penalties. Unbounded use of non-competes could lead to unintended and very negative consequences, so it’s best to consult with someone very knowledgeable about non-competes before moving forward with them.
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