Computing and Administering Separation Pay in the Philippines

This article explains how to compute and administer separation pay in the Philippines. It details the formulas for different types of termination and outlines the legal requirements employers must follow. This guide aims to help both employers and employees understand the separation pay process.

What is a separation pay?

Separation pay, severance pay or termination pay refers to the compensation an employee receives upon leaving the company. During situations like layoffs, company downsizing, close of business or mutual agreement, employers may choose to provide separation pay.

This voluntary benefit is provided by employers to alleviate the impact of termination, to support the employee through retirement or until they find new employment. A typical separation pay package may also include benefits such as continued health insurance, outplacement services, or payment for unused vacation days.

In the Philippines, employers must provide severance pay to employees terminated with authorized causes under the Labor Code. If an employer defaults on their obligation, employees can file a complaint with the Department of Labour and Employment (DOLE). The department will investigate the complaint and may initiate conciliation or mediation proceedings to resolve the issue. If the employer fails to comply, DOLE can impose penalties and sanctions, including legal action to enforce compliance.

What is the difference between final pay and separation pay?

Final pay and separation pay are both types of compensation an employee receives when their employment ends. However, their purposes and calculations differ.

Employees are entitled to receive their final pay, regardless of the reason for leaving. It typically includes unpaid salary or wages, accrued but unused vacation or paid time off (PTO), and any other earnings such as bonuses, commissions, or overtime pay that are due.

Unless provided under employer's discretion or stated in their employment contract, employees receiving separation pay upon termination aren't entitled to a final pay. This is an added compensation provided to support employees during the transitions period after leaving the organization.

Separation pay is calculated based on factors such as length of service, position and reason for termination. Final pay is calculated differently. It is calculated based on the benefits accrued and whether the employee is salaried, or paid on an hourly basis. 

The timing is also different. Final pay is usually provided on the employee’s last working day or shortly thereafter, depending on company policy and local labor laws. While for severance pay, the timing and amount is outlined in the severance agreement which may be based on company policy, employment contracts, or collective bargaining agreements. For example, an employment contract might specify that severance pay is provided as a lump sum within 30 days of termination. 

Relevant reading: How to Compute Overtime Pay in the Philippines

Who qualifies for separation pay?

Eligibility is a major requirement for companies when administering severance pay. Without it, employees wouldn't qualify for severance benefits when their employment ends. These criteria ensure fairness and protect the company from legal issues. 

Also, without clear eligibility, disputes could arise over who gets severance pay and why. Here we've listed common scenarios where employees typically qualify for separation pay, as well as cases where they do not:

Redundancy

There may be times when the position held by an employee is no longer necessary. This may be due to overstaffing, restructuring, technical changes or other reasons leading to a reduced need for such a position. To ease the impact of redundancy during this period, companies often offer severance pay. 

Closure or cessation of operation

A layoff can happen when a company, or a part of it, shuts down completely. This may be due to financial difficulties, or other significant changes in the business environment. Such individuals qualify for severance pay to provide financial support during the transition period as they seek new employment and to compensate for the sudden loss of their job through no fault of their own.

Reduction of workforce

This is otherwise known as Reduction in Force (RIF), which is a corporate term that refers to a situation where a company decreases the number of its employees. This can be done to cut costs, or a restructuring that leads to improved changes and adaptation to market changes. When such layoffs happen, based on the employment contract or the goodwill of an employer, employees can be let go with severance packages. 

Dismissal without cause

Another case where your workers may be qualified for a separation pay is when there is a termination of employment without any fault or misconduct by the employee. For example, an economic downturn that forces a company to let go of employees despite their satisfactory performance.

Under the Labor Code, other criteria include the installation of labor-saving devices, where a company installs new technology that makes certain positions redundant. Additionally, in the case of employees who suffer from a disease that cannot be cured within six months and continued employment is prejudicial to their health and that of their co-workers, these employees are entitled to separation pay.

Now, it’s important to note that criteria stated above are authorized cases. Authorized here refers to situations where the termination is justified under specific conditions outlined by Philippine labor laws, or company's policy. 

However, there may be cases where employees who are being terminated from their job aren't qualified to receive severance pay. 

This may be due to the following reasons:

Dismissal for just cause: This refers to violations done by employees that led to their termination from work. These violations include gross misconduct such as theft, fraud or serious breaches of company policy. Also, when an employee fails to meet job expectations despite warnings and support then the employee has a fair reason to layoff the employee. 

Voluntary resignation: Employees who voluntarily choose to leave their work, whether due to personal reasons or to take up a new role at another company, typically do not qualify for a severance package. This is because severance pay is generally intended to support employees who lose their jobs through no fault of their own, such as during layoffs or company closures. When an employee resigns voluntarily, they are making a personal decision to leave, and the employer is not obligated to provide additional financial support beyond final pay for the work already performed.

Completion of a contract: A contractor or temporary employee whose contract ends without renewal is also not qualified for severance package. 

Retirement: When an employee reaches the company's retirement age or retires as per the retirement policy, they typically do not receive severance pay. This is because retirement is a planned and anticipated event, often accompanied by other retirement benefits such as pensions or retirement savings plans, which are designed to provide financial support post-employment. Therefore, the need for severance pay, which is intended to support employees who face unexpected job loss, does not usually apply in the case of retirement. 

How is separation pay calculated?

As per Article 298 and 299 of the Labor Code,  separation pay is calculated based on the reason for termination and the employee's length of service.

The Labor Code further states that in cases of installation of labor-saving devices or redundancy, the employee is entitled to receive the equivalent of one month pay for every year of service. 

Hence the formula: 

Separation pay = (one month salary) × (years of service)

While in the case for closure or cessation of business, or health reasons, the employee receives one month pay or half a month pay for every year of service. 

Hence the formula for half a month pay: 

Separation pay = (one month salary) ÷ 2 × (years of service)

How is separation pay administered?

The following are ways Philippine employers can administer separation pay that adheres to the laws: 

Notice of termination

A written notice must be provided to let the employee know about the termination of their contract. The notice should include the reason for termination, the effective date, and information about the severance package, if applicable. 

When breaking the news, communicate this with professionalism and empathy. In the Philippines, employees must provide the written notice 30 days before the termination date and the document should outline the grounds for dismissal. A copy of the notice should be provided to the Regional Office of the Department of Labour and Employment where the employer is located.

Read next: What is a Notice Period?

Payment

The amount and conditions of separation pay are specified by the labor laws and may depend on factors such as the length of employment and the reason for termination. 

Employers can choose to provide severance pay in lump sums or in installments. Both modes of payment have different advantages, and employers should carefully consider which option is beneficial for both parties.

Severance payments should be provided in line with the company policy, or the severance agreement. 

Timing is an important factor here. It must comply with legal requirements or company policy, and outlined in the severance agreement.

Tax withholding

Severance payments are subject to federal and state income taxes, and Filipino employers must withhold these taxes. Other deductions like SSS contributions, Medicare, and mandatory withholdings also apply.

Read next: Preparing for ITR Philippines

Documentation

This is a crucial step as it provides a clear record of the terms and conditions of the separation. Proper documentation includes the severance agreement, which outlines the payment details, any continued benefits, and any conditions such as a release of claims. Both the employer and the employee should sign this agreement to ensure mutual understanding and acceptance. This helps prevent future disputes and ensures compliance with legal and contractual obligations.

Additional considerations

• Collective Bargaining Agreements (CBA): If your company has a union, you need to take into account clauses stipulated in the CBA when administering separation pay. 
• Legal consultation: Consult a legal professional to ensure you are doing everything by the books.This prevents potential legal disputes and warrants that all actions taken are fair and lawful.

Leveraging HR Tools for Accurate Pay Calculations

Ensuring accurate pay calculations when administering separation pay is crucial for both employees and employers. It not only assures that you are complying with labor laws, but also fosters trust and fairness in the workplace. 

Optimizing payroll management with HR software like Omni can streamline your processes, reduce errors, and improve overall efficiency when calculating severance pay in the Philippines.

With features like support for Philippine peso, automated tax calculations, and managed SSS, PhilHealth and PAG-IBIG contributions, Omni can help HR simplify your payroll processes and ensure compliance to the Labor Code with ease. 

Schedule a chat with our team today!

Try out Omni for 14 days and see how our all-in-one HR software can simplify the intricacies and complexities of your entire end-to-end employee lifecycle and minimize the costs associated with common errors when it comes to severance pay calculations.