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How Should Severance Pay Be Managed?

The question of how to handle severance pay is a crucial one for both employees and employers. Let's explore this topic from both perspectives, referencing Korea's Labor Standards Act to shed light on the legal framework.

For Employees: The Benefit of a Higher Final Salary

From an employee's perspective, it’s most advantageous to receive severance pay based on the average salary during the final three months of employment. Why? The final months typically reflect the highest salary due to raises, bonuses, or other benefits accrued over time.

In Korea, under the Labor Standards Act, severance pay must be calculated as at least 30 days of average wages for each year of service if the employee has worked continuously for at least one year. This regulation ensures employees receive a fair settlement based on their recent earnings, particularly if their salary has increased.

For Employers: The Cost-Saving Advantages of a Retirement Pension Plan

Employers, on the other hand, often find it more economical and financially manageable to contribute 1/12 of the employee’s monthly salary into a retirement pension plan. Why is this preferable?

  1. Salary Growth Mitigation: By locking in contributions based on current salaries, employers avoid paying higher severance amounts tied to future salary increases.

  2. Cash Flow Management: A retirement pension plan allows employers to spread severance costs over time, rather than facing a sudden large cash outflow when an employee leaves.

For small and medium-sized businesses (SMEs), this approach can safeguard the company's financial stability and reduce the risk of failing to meet severance obligations.

What Happens When the Company Cannot Pay Severance?

If a company fails to pay severance due to financial troubles, it risks both civil and criminal liability under Korean law.

  1. Criminal Penalties: According to the Labor Standards Act, Article 36, employers must pay severance within 14 days of the employee's termination. Failing to do so is a legal violation, subjecting the employer to potential fines or imprisonment.

  2. Civil Liability: Employees can file lawsuits to claim their unpaid severance, resulting in additional legal and financial burdens for the employer.

In extreme cases, if the company becomes insolvent or declares bankruptcy, employees can apply for a Wage Claim Guarantee through the Ministry of Employment and Labor. The government compensates employees for unpaid severance, then pursues reimbursement from the employer.

Key Takeaways for Employers and Employees

For Employees:

  • Ensure your severance pay reflects your average salary during the last three months of employment.

  • If severance is unpaid, promptly file a claim with the Ministry of Employment and Labor and consider legal action.

For Employers:

  • Establish a retirement pension plan to distribute severance costs over time and manage financial risks.

  • Avoid legal disputes by adhering to the 14-day payment deadline after an employee's departure.

The Bigger Picture

Handling severance pay is not just a legal obligation but also a matter of trust and financial foresight. Employees and employers alike should take proactive measures to protect their rights and obligations. For employers, compliance with Korea’s labor laws isn’t just about avoiding penalties—it’s about fostering a positive and stable workplace culture. For employees, understanding your rights ensures you receive the compensation you’re entitled to.

By navigating this process carefully, both sides can avoid disputes and ensure a smoother, fairer transition when employment ends.


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