You May Want to Distribute Your Severance Pay

While it’s always difficult to lose your job , the severance pay offered by your employer can soften the blow. However, before accepting a lump sum severance pay, it is worth considering the benefits of spreading your severance pay over a longer period. And this advice isn’t just about extending payouts for recently laid-off workers. Because severance pay is taxed like ordinary income, spreading it out over time is an easy way to keep yourself in a lower tax bracket.

If you’ve recently lost your job, here’s what you need to know about how your severance pay will be taxed and how you can make the most of your severance pay.

Is severance pay taxable?

The severance pay is taxed in the same way as ordinary income on ordinary income taxes. This means you will pay federal income tax, Social Security, Medical Assistance, and federal unemployment tax on your severance pay just like you would on your regular wage. So while you can’t (legally) avoid taxes on severance pay, there are ways to strategically minimize your tax burden.

Why distribute severance pay?

The distribution of severance pay provides several benefits that will help you manage your finances more effectively:

tax incentives

If you want to pay less taxes, you must pay severance pay over two separate years. If you are expecting lower income next year, it may be beneficial to defer payment until then to lower your tax bracket this year. Otherwise, getting one big lump sum now could push you into a higher tax bracket.

If your severance pay includes a pension or retirement plan, consider transferring it to an appropriate tax-favored account. This could be your IRA, 401(k) or even HSA. This step can help you defer taxes on that portion until you withdraw funds in the future.

Extended health insurance

Many severance pay includes fixed-term health insurance. By redistributing the package, you can extend your access to these benefits.

Stable income stream

Choosing recurring payments ensures a steady stream of income, helping you maintain financial stability over the long term. And with that stability comes the freedom to take your time looking for the right job, rather than rushing into a decision because of financial pressures.

Tips for distributing severance pay

Read the terms of your severance pay carefully to understand the amount of the lump sum offered, the potential duration of the payments, and any other benefits included in it.

Consider writing a formal proposal outlining your reasons for requesting extended severance pay. Highlight the benefits for both you and the company, such as reduced tax liability and having a dedicated employee during any existing transition period.

Be prepared to negotiate . Your employer may have their own issues, so be flexible and ready to find a middle ground that will satisfy both parties. Once an agreement is reached, make sure all the details are in writing. This will serve as a guide to avoid misunderstandings in the future.

bottom line

Asking for a severance package can be a strategic move that will benefit both your financial stability and the company’s transition process. Although it is not possible to completely avoid paying severance pay tax, you can take the initiative to reduce the amount of severance pay that will be taxed. Be sure to get advice from a financial professional to get the best tax breaks for your personal situation.