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Severance Pay: Will IRS Still Consider It As Extra Income?

Severance Pay
NEW YORK, NY - JUNE 08: A Toys R Us store stands in Brooklyn on June 8, 2018 in New York City. All 735 Toys R Us stores in America are set to close by the end of June leaving 33,000 workers without a job or severance pay. Many of the employees losing their jobs have worked for the company for decades. Toys R Us has been owned by the private-equity giant Bain Capital. (Photo by Spencer Platt/Getty Images)

Severance pay packages, the pay provided to certain departing employees, have come under new scrutiny due to persistent economic worries and a wave of layoffs in the IT sector. 

Severance packages provide newly unemployed workers with a financial cushion as they navigate an unstable job market. They range greatly in size and duration. 

However, laid-off employees might not completely comprehend the conditions of a severance package or could feel under pressure to accept them without carefully reading them.

Severance Pay

CHICAGO – DECEMBER 8: U.S. Sen. Dick Durbin (D-IL) speaks to the media after visiting with workers occupying the Republic Windows and Doors factory December 8, 2008 in Chicago, Illinois. About 200 workers, who got three days’ notice their factory was shutting down, are occupying the facility in shifts demanding severance and vacation pay they say they are owed. (Photo by Scott Olson/Getty Images)

Severance Package Explained

The quantity and length of additional compensation and benefits a worker receives are the most erratic aspects of a severance agreement. 

CBS News said the severance package includes:

  • financial compensation
  • extension of benefits, including health care 
  • a percentage of your bonus 
  • Accelerated stock vesting 
  • Assistance with job placement or career counseling

US Department of Labor said the business must provide you at least 60 days’ notice if your job loss is a result of a mass layoff under the Worker Adjustment and Retraining Notification (WARN) Act. Throughout the notice period, employees are entitled to their full compensation.

It is the responsibility of departing employees to make sure they understand the severance pay package before accepting it, severance experts told ABC News, as there is no standard template used for the agreements. 

How Your Employer Calculates Severance Pay

ABC News added that the cash compensation provided in severance pay agreements is calculated in a variety of ways, from conservative to extravagant. 

Favorable severance packages provide one month’s income for each year of employment, but more economical packages only offer one week’s salary for each year, according to experts. 

A laid-off employee’s compensation at the top of the range, for example, would equal over a half year’s worth of salary if the individual had worked for the business for five years.

ALSO READ: Texas Increases Starting Salary And Compensation For State Hospital Employees

Is that considered income for IRS limits on Roth IRA contributions?

Severance pay is liable to income-tax withholding and payroll taxes since it is seen by the IRS as extra earnings. 

Nilay Gandhi, senior wealth adviser at Vanguard told Market Watch (via MSN) that “generally speaking,” severance money does count towards the Roth IRA income limits — unless the company expressly excludes the severance, and the employee should inquire with their employer if it will be regarded as taxable income or not.

The possibility of a “backdoor” Roth IRA conversion exists even if your income disqualifies you from making direct Roth IRA contributions due to salary plus severance pay.

RELATED ARTICLE: The Great Debate: Salary Continuance Vs Lump Sum Payments, Which Is Best For You?

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