How to Minimize Taxes on Severance Pay

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How to Minimize Taxes on Severance Pay

Being laid off is never good news, but if you get a severance payment, it may be beneficial to your savings account. It may enable you to complete training while looking for a new employment, increase your emergency savings, or pay off debt. However, many individuals overlook the fact that they will have to pay taxes on their severance money. Fortunately, there are various strategies to reduce the tax burden. Continue reading to learn ways to reduce your tax burden to Uncle Sam.

Key Takeaways

  • By moving your severance payout to an IRA, you may lower your tax liability.
  • If you have a high-deductible health insurance plan, consider investing part of your severance pay into an HSA.
  • Ask your employer whether you may be paid over a two-year period.
  • You may put part of your package money into a 529 plan.
  • Consider donating your severance compensation to your preferred charity via a donor-advised fund.

Contribute to a Retirement Account

Contributing to a tax-deferred account, such as an individual retirement account, is a simple method to pay less tax on severance pay (IRA).For the tax years 2021 and 2022, the contribution ceiling is $6,000 per person. If you are above the age of 50, you may contribute an extra $1,000 as a catch-up payment.

Financial gurus advise you to save as much as possible. According to Brunch and Budget’s Pamela Capalad, a certified financial planner (CFP), you should aim to give the greatest amount if possible.

Some companies may even let you to contribute your severance money to your 401(k) (k).The maximum for 2022 is $20,500 (the limit for 2021 is $19,500). If you are above the age of 50, you may save an extra $6,500.

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Put It Toward Health Expenses

If you have a high-deductible health plan (HDHP), depositing your severance money in a health savings account (HSA) is a wonderful method to prepare for future expenditures if you don’t want to put it toward retirement.

For 2021:

You may contribute up to $3,600 for self-coverage and up to $7,200 for family plans as long as you:

  • Your deductible exceeds $1,400 for single coverage or $2,800 for family coverage.
  • Your out-of-pocket payments are limited to $7,000 for self-only coverage and $14,000 for family coverage, respectively.

For 2022:

You may save up to $3,650 on self-coverage and up to $7,300 on family insurance if you meet the following criteria:

  • Your deductible exceeds $1,400 for single coverage or $2,800 for family coverage (same as 2021)
  • Your out-of-pocket expenditures are limited to $7,050 for self-only coverage and $14,100 for family coverage.

Time Your Payout

Paying your severance in two different years is a simple method to pay less tax. Ask whether the payments may be spaced out to prevent a large tax bill in one year. Taking a lump amount might result in unanticipated tax liabilities for certain persons.

According to Tyler Landes CFP, certified investment fiduciary (AIF) and founder of Tandem Financial Guidance, “receiving a single substantial lump-sum payout might put you into a higher tax rate.” “That might result in significant adjustments to the amount you owe.”

Make sure to get assistance from a financial advisor to ensure that you receive the maximum potential tax advantages for your specific scenario.

Open a 529 Plan

Consider investing your severance money in a 529 plan if you have children or wish to assist a young niece or nephew’s college education. Contributing may potentially entitle you to state tax breaks.

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Please carefully read the regulations to ensure that your donation does not qualify as a gift. You don’t want to make matters worse for yourself while attempting to reduce your tax burden.

You may also utilize a 529 to pay off up to $10,000 of your own student loan debt under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. It may make sense to form a 529 account, take advantage of any applicable state tax advantages, and quickly repay student debts.

Invest in a Donor-Advised Fund

A donor-advised fund is a one-of-a-kind option to offset the taxes you’d pay on your severance while also helping your chosen charity. The nicest aspect about the donor-advised fund is that it enables a person to obtain a tax advantage while also having a vote in how money is distributed to an organization.

According to Landes, “these accounts are sponsored by national philanthropic organizations and store your donations and allow them to develop for future disbursements or awards.”

The Bottom Line

If you discover out you’re getting a severance payout and aren’t sure what to do, consult with a specialist. Even if you believe you know what’s best for your money, a certified public accountant (CPA), a certified financial planner (CFP), or other financial specialists may provide advice.

“Buyouts are a true gift, so prepare properly,” said Crystal Brook Advisors CEO Peter J. Creedon. “Before making a significant financial choice, you must view and grasp the whole picture.”

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