How to Compute Retrenchment Pay in the Philippines

(Labor Code and DOLE rules — practical guide for employers and employees)

1) Quick snapshot

What it is: “Retrenchment pay” is the separation pay owed when an employer validly retrenches employees to prevent losses (an authorized cause of termination).
Amount: One (1) month pay or one-half (1/2) month pay for every year of service, whichever is higher.
Rounding: A fraction of at least six (6) months counts as one whole year of service.
Base: Latest basic monthly salary (include wage-integrated regular allowances; exclude OT/premiums unless a CBA/company policy says otherwise).
Tax: Generally tax-exempt (involuntary separation for causes beyond the employee’s control).
Notice: 30 days’ prior written notice to the employee and to the DOLE (Establishment Termination Report).
Proof: Retrenchment must be in good faith, supported by substantial, actual or reasonably imminent losses (typically shown by audited financial statements) and fair selection criteria.

2) Legal bases (plain-English)

Labor Code (as renumbered) — Authorized causes: Article 298 [formerly 283] covers installation of labor-saving devices, redundancy, retrenchment to prevent losses, and closure/cessation. It prescribes separation pay and the 30-day dual notice rule.
IRR / DOLE rules: Book VI IRR and DOLE department orders/labor advisories detail notice, reporting, and computation mechanics (e.g., 6-month rounding).
Key jurisprudence (guideposts):
- Necessity & proof of losses: Retrenchment requires serious, actual or imminent losses and credible proof (audited FS).
- Good faith & criteria: Employers must act in good faith and apply fair and reasonable selection criteria (e.g., efficiency, seniority).
- Due process lapses: Failure to give proper 30-day notice does not invalidate an otherwise valid authorized-cause termination, but commonly results in nominal damages; if the cause is unproven, dismissal is illegal (reinstatement/backwages).

(You don’t need case names to compute; these principles are now standard.)

3) When retrenchment is allowed (checklist)

To be valid, the employer should be able to show:

Losses are real — actual or reasonably imminent (not speculative).
Losses are substantial — not trivial; supported by audited numbers or similarly weighty proof.
Good faith — retrenchment is a last resort after cost-saving alternatives.
Fair selection — objective criteria (efficiency ratings, seniority, disciplinary record, skill fit) consistently applied.
Procedure — written notice to the employee and DOLE at least 30 days before effectivity + timely payment of separation pay on or before separation date (or as per DOLE advisory on final pay).

Important contrasts:

Closure due to serious losses: no separation pay required.
Closure not due to serious losses: 1 month or 1/2 month per year, whichever higher (same as retrenchment).
Redundancy / labor-saving devices: typically 1 month per year of service (with a floor of 1 month).

4) The computation formula

4.1 Define the “one month pay”

Use the employee’s latest basic monthly salary at the time of separation.
Include regular monetary allowances that are wage-integrated by practice, policy, or CBA (e.g., COLA).
Exclude: overtime pay, night differential, holiday/premium pay, discretionary bonuses, profit-sharing, and non-wage benefits—unless your CBA/company policy expressly includes them.

4.2 Core formula

Retrenchment separation pay = the higher of:

(A) One (1) month pay, or
(B) One-half (1/2) month pay × Years of service (YOS)

Years of service (YOS): Count full calendar years; round up any fraction ≥ 6 months to one (1) full year.

Tip: If (B) is less than one month, pay one month (the statutory floor).

4.3 Common components paid at separation (in addition to separation pay)

Unpaid wages up to last day worked
Prorated 13th-month pay (Jan–separation month)
Unused SIL/vacation leave conversion (if convertible by law/policy/CBA)
Other accrued benefits per policy/CBA
Tax treatment: Separation pay for retrenchment is tax-exempt; ordinary wage items keep their usual tax rules.

5) Worked examples

Example 1 — Monthly-paid, 2 years 4 months’ service

Latest monthly basic pay: ₱30,000
YOS: 2.33 years → 2 years (only 4 months beyond 2; less than 6)
(A) One month pay = ₱30,000
(B) 0.5 × 2 × ₱30,000 = ₱30,000
Separation pay = higher of A or B = ₱30,000

Example 2 — Monthly-paid, 2 years 7 months’ service

Latest monthly basic pay: ₱30,000
YOS: 2 years 7 months → 3 years (≥6 months rounds up)
(A) = ₱30,000
(B) 0.5 × 3 × ₱30,000 = ₱45,000
Separation pay = ₱45,000

Example 3 — With a regular integrated allowance

Basic salary ₱25,000 + regular COLA ₱2,000 → One month pay = ₱27,000
Tenure: 5 years 6 months → 6 years
(A) = ₱27,000
(B) 0.5 × 6 × ₱27,000 = ₱81,000
Separation pay = ₱81,000

Example 4 — Daily-paid worker (stabilize to a monthly base)

Daily rate: ₱800
Company treats monthly equivalent as 26 days for benefits: ₱20,800
Tenure: 1 year 2 months → 1 year
(A) = ₱20,800
(B) 0.5 × 1 × ₱20,800 = ₱10,400
Separation pay = ₱20,800 (floor wins)

Note: Use your company’s lawful conversion for daily→monthly (e.g., 26 or 313/12), and apply it consistently.

6) Procedural roadmap (step-by-step for employers)

Diagnose necessity
- Explore cost-saving alternatives first (reassignments, reduced hours, attrition, furloughs).
- Document why retrenchment is the least injurious option.
Evidence of losses
- Prepare audited financial statements (or comparable independent proof) showing actual or imminent, substantial losses.
- Draft a management report tying the numbers to roles/functions being affected.
Selection criteria
- Set clear, objective criteria (efficiency, seniority, redundancy of functions, skill mismatch).
- Apply criteria consistently; keep a matrix or scoring sheet.
30-day dual notice
- Employee notice: Written, stating authorized cause, effective date, selection criteria, and benefits.
- DOLE notice: File the Establishment Termination Report (often referred to as RKS Form 5 for retrenchment/closure), at least 30 days before effectivity.
Payout & clearance
- Compute separation pay + final pay (wages, prorated 13th month, convertibles).
- Target payment on or before separation date; document the release/quitclaim properly (no undue pressure; disclose computation).
Post-separation support (optional but helpful)
- Provide COE (Certificate of Employment).
- Guide employees on SSS unemployment benefits (available for involuntary separations like retrenchment; requires DOLE certification).

7) Employee’s quick rights list

Advance written notice (30 days) and report to DOLE.
Separation pay per formula (higher of one month or 1/2 month per year; 6-month rounding).
Final pay (unpaid wages, prorated 13th month, convertible leaves, etc.).
Tax exemption for the separation pay component.
Challenge the retrenchment if unsupported by genuine losses, done in bad faith, or criteria were unfairly applied.
SSS unemployment benefits application (time-bound; keep DOLE certification and employer notice).

8) Frequent pain points & how to avoid them

Insufficient proof of losses: Use audited figures and connect them to the retrenchment plan.
Token criteria: Write down specific, weighted criteria; avoid vague “management discretion.”
Notice defects: Count 30 calendar days; keep proof of service and DOLE filing.
Computation mix-ups: Don’t import retirement formulas (those add 13th-month and SIL components) into retrenchment.
Base pay confusion: Start with latest basic monthly pay; include only wage-integrated regular allowances unless your CBA/policy broadens it.
Daily-paid conversions: Pick a lawful, consistent monthly equivalent (e.g., 26 days or 313/12) and apply it uniformly.
Quitclaims: Ensure full disclosure of computation and no coercion; pay uncontested amounts promptly.

9) Practical computation template

Inputs:

Latest basic monthly pay (plus wage-integrated regular allowances)
Tenure (with 6-month rounding)
Company’s daily→monthly conversion rule (if needed)

Steps:

Determine One Month Pay.
Compute Half-Month-per-Year = 0.5 × YOS × One Month Pay.
Retrenchment Pay = max(One Month Pay, Half-Month-per-Year).
Add: Unpaid wages + prorated 13th month + convertible leaves + other accrued benefits.
Apply tax rules (separation pay: exempt; others: ordinary).
Document the breakdown and have both parties acknowledge.

10) FAQs

Q: Are probationary or project employees covered? A: If lawfully retrenched (not project completion/expiry), yes, the same formula applies; compute based on actual service with the 6-month rounding.

Q: Does service break reset YOS? A: Continuous service is typical; for breaks, apply your lawful policy/CBA and Philippine rules on interruption (e.g., authorized leaves don’t break service).

Q: Is there separation pay if the company is losing heavily and closes? A: Closure due to serious losses: none. Closure not due to serious losses: pay one month or 1/2 month per year, whichever is higher.

Q: Can company policy or a CBA grant more? A: Yes. The Labor Code sets minimums. A policy/CBA can add (e.g., include allowances, grant higher multipliers).

Q: Is the quitclaim always valid? A: Generally valid if voluntary, informed, and for a reasonable consideration. Coercion or fraud can invalidate it.

Q: When must final pay be released? A: As a rule of thumb, on or shortly after the effectivity date; follow DOLE advisories (some reference within 30 days, unless a quicker timetable is in your policy/CBA).

Q: Can employees also claim unemployment insurance? A: Yes (SSS unemployment benefit) for involuntary separations like retrenchment, subject to eligibility and timely filing with a DOLE certificate.

11) Clean, portable clause (sample—adapt to your policies/CBA)

Separation Pay (Retrenchment). If the Company implements a valid retrenchment under the Labor Code, the employee shall receive separation pay equivalent to the higher of (a) one (1) month pay, or (b) one-half (1/2) month pay for every year of service, with a fraction of at least six (6) months counted as one (1) whole year, computed on the basis of the employee’s latest basic monthly salary, inclusive only of regular wage-integrated allowances, exclusive of overtime/premium pay, unless otherwise provided by CBA or Company policy. All statutory final pay items (unpaid wages, prorated 13th-month, convertible leaves) shall also be settled.

Bottom line

To compute retrenchment pay in the Philippines, lock in the correct base, round service properly, take the higher of one month vs. half-month-per-year, and document notice, evidence of losses, and selection criteria. This not only yields the right figure—it also makes the retrenchment legally defensible.