Getting laid off is never good news, but if you get a severance package, it can be a saving grace while you look for a new job. Severance pay can allow you to do training while you job hunt, bump up your emergency fund, or pay off debt to minimize monthly bills while you are unemployed. Many people do not know that they will have to pay taxes on their severance pay. Thankfully, there are several ways to lessen the tax burden.
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Contribute to Retirement Account
One easy way to pay fewer taxes on severance pay is to contribute to a tax-deferred account like an individual retirement account (IRA). The contribution limit is $6,000 for 2019. If you’re over 50, you can put $1,000 more. Many professionals advise that you try to contribute the max amount allowable, if you are able to take advantage of that opportunity. Another option is 401(k) contributions. Some employers might allow you to put your severance pay into your 401(k). The 2019 limit is $19,000 and an additional $6,000 if you’re over 50.
Put It Toward Health Expenses
For those who have high-deductible health insurance plans, putting your severance money in a health savings account (HSA) is a great way to plan for future expenses that can quickly drain your savings account when a medical emergency occurs.
Time Your Payout
An easy way to pay fewer taxes is to have your severance paid out in two separate years. Ask if you can have the payments spread out so you can avoid taking a huge tax hit in one year. For some people, taking a lump sum can mean owing unexpected money on your taxes. If you receive a large lump-sum for your severance payout, it could push you into a higher tax bracket.
Open a 529
If you have kids under 18 years of age, you could use your severance pay to invest in a 529 plan for them. You may even be eligible for some state deductions for contributing. Make sure to read through the rules carefully to see what the limits are so your contribution doesn’t count as a gift. You don’t want to cause more of a headache for yourself while you’re trying to lessen your tax burden.