Buzz
While losing a job is always a tough experience, a severance package can help ease the situation. However, before agreeing to a one-time payment, think about the potential advantages of receiving your severance over time. This isn’t just for those recently laid off. Severance pay is subject to regular income tax, so opting for installments can help you stay within a lower tax bracket.
If you've recently been let go, it’s important to understand how severance pay is taxed and how you can optimize your severance benefits.
Is severance pay subject to taxation?
Severance pay is taxed the same way as your regular income, based on the standard income tax brackets. This means that it will be subject to federal income taxes, Social Security, Medicare, and federal unemployment tax, just like your usual wages. While it’s not possible to completely avoid taxes on severance, there are strategies you can use to reduce your overall tax burden.
Why opt for a split severance payout?
Choosing to receive your severance package over multiple payments can offer a variety of benefits, allowing you to better manage your financial situation.
Tax advantages
To reduce your taxes, consider having your severance divided and paid across two different years. If you expect to earn a lower income next year, it may be beneficial to postpone part of the payment to the following year, which could help you avoid a higher tax bracket this year. On the other hand, if you take the full payment at once, it might push you into a higher tax bracket for the current year.
If your severance includes a pension or retirement distribution, you may want to roll it over into a qualified tax-advantaged account, such as an IRA, 401(k), or even an HSA. Doing so allows you to defer taxes on that portion until you eventually withdraw the funds in the future.
Continued health coverage
A number of severance packages offer health insurance for a set period of time. By choosing to spread out the payments, you may be able to extend your access to these health benefits.
Reliable income flow
Opting for scheduled payments ensures a steady income over time, providing you with financial security. This stability offers you the freedom to carefully consider your next job opportunity, without the pressure of needing to accept something quickly due to financial constraints.
Guidelines for distributing your severance pay
Take the time to thoroughly review your severance agreement, paying attention to the lump sum offered, how long the payments may last, and any additional benefits that are included.
Consider putting together a formal proposal that outlines your reasons for requesting a distribution of your severance pay. Highlight the advantages for both you and the company, such as lowering your tax liability and ensuring continuity by keeping you as a committed employee during any transition phase.
Prepare for negotiation. Your employer may have their own considerations, so be open to compromise and aim to reach a solution that works for both sides. Once an agreement is made, ensure everything is documented in writing to prevent future confusion.
The key takeaway
Choosing to distribute your severance pay over time can be a wise decision that supports both your financial security and the company's transition. While taxes on severance are unavoidable, you can take steps to minimize the taxable portion. Be sure to consult with a financial expert to maximize the tax advantages based on your unique financial situation.
