Severance pay is a voluntary offer of payment by employers to terminated employees. Severance pay may serve as a cushion while you look for work, but if you find a new job quickly it may become a windfall. One option that may be available is tucking that extra money into a traditional or Roth individual retirement account.
IRA Contribution Rules
The Internal Revenue Service classifies severance pay as taxable compensation like wages and salaries. Severance pay is reported on your W-2 form and employers must withhold payroll taxes on the money. The IRS requires that you have taxable compensation at least equal to the amount you contribute to an IRA up to the annual limit. As of 2014, the IRA contribution limit was $5,500. For people age 50 and over, it was $6,500. Since severance pay is compensation, it can be used for IRA contributions.
IRA Income Limits
Severance pay might push you over IRA income limits when it’s added to your other income. For traditional IRAs, this means you might not be able to deduct all or part of your IRA contribution if you or your spouse is covered by a retirement plan at work. If your adjusted gross income exceeds Roth IRA income limits, the effect is to reduce or eliminate the amount of your IRA contribution you can deduct. Limit amounts depend on your filing status. For example, as of 2014, the adjusted gross income limit for a full deduction for a single taxpayer was $60,000, while for a married taxpayer filing jointly, the limit was $96,000.
- American Association of Retired People: Read This Before Accepting a Severance Offer
- IRS Publication 4128: Tax Impact of Job Loss
- IRS: Retirement Topics – IRA Contribution Limits
- U.S. Department of Labor. "Severance Pay." Accessed Aug. 16, 2020.
- U.S. Department of Labor. "Wages and the Fair Labor Standards Act." Accessed Aug. 16, 2020.
- NBC News. "While Sears executives get $25 million in bonuses, laid-off workers struggle during Christmastime." Accessed Aug. 16, 2020.
- New York State Department of Labor. "Dismissal or Severance Pay and Your Unemployment Insurance Benefit." Accessed Aug. 16, 2020.
Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.