By Losing your job can be stressful, but a severance package can provide a financial cushion during your transition. However, understanding how severance pay affects your taxes and overall financial situation is crucial to making the most of this benefit.
Is Severance Pay Taxable?
Yes, severance pay is treated as taxable income in the year you receive it. Employers typically withhold taxes from your severance payment, either as:
- Regular wages (based on your W-4 withholdings)
- Supplemental income (subject to a flat 22% federal withholding rate)
Keep in mind that state and local taxes may also apply, depending on where you live.
How Severance Pay Affects Your Tax Bracket
A large severance payment could push you into a higher tax bracket for the year, meaning a greater percentage of your income goes to taxes. This could also impact your eligibility for certain tax credits or deductions tied to income thresholds. To mitigate this, consider:
- Maximizing retirement contributions (IRA, 401(k) if available)
- Contributing to an HSA (if eligible)
- Spreading payments over multiple years (if possible)
Unemployment Benefits and Taxes
Some states allow you to collect unemployment benefits while receiving severance, but both are taxable. To avoid a surprise tax bill, request withholding from unemployment payments—typically at 10% for federal taxes (and any applicable state taxes).
Healthcare Considerations After Job Loss
Losing employer-sponsored health insurance qualifies you for a Special Enrollment Period in the Health Insurance Marketplace. Depending on your income, you may qualify for premium tax credits, reducing your monthly healthcare costs. COBRA is another option, though often expensive without employer subsidies.
Making the Most of Your Severance
While severance pay can ease financial strain, smart planning is key:
- Budget carefully to extend your runway while job searching
- Explore rolling severance into a retirement account to reduce taxable income
- Consult a tax professional to optimize withholding and deductions
Final Thoughts
A severance package can provide much-needed stability during career transitions, but proper tax planning ensures you keep more of what you’ve earned. By understanding withholding rules, adjusting for potential tax bracket changes, and exploring healthcare options, you can navigate this period with confidence.
If you’re unsure about your specific situation, a financial advisor or CPA can help tailor a strategy to your needs.