If you quit your job or get fired, then chances are that you will receive a severance package which is usually the last payment that you will receive from your employer and this pay is supposed to help you transition from one job to the next or at least help you start a business.
Nevertheless, the severance pay is still viewed as pay by the IRS, and that means it has to be taxed. However, some steps can help you minimize the amount of tax you will be required to pay. Here are some tips that can help reduce the amount you will be required to pay from your severance package.
Create a 529 plan for your children
If you have children, consider creating a 529 plan through which you can save cash for their education in the future. Your contributions to the 529 plan qualify for state deductions, thus effectively reducing the taxable amount.
Divert your severance package towards covering health expenses
Consider putting your severance money in a health savings account, especially if your health insurance plans have high deductibles. This will allow you to plan more effectively by using the money to cover future expenses.
Use the severance pay to make retirement contributions
You can use part of your severance pay to contribute to a tax-deferred retirement account. The maximum contribution for 2019 and 2020 was set at $6,000 and $7,000 for individuals over 50 years old. Contributing to your retirement account will reduce the taxable amount, thus allowing you to pay less tax from your severance pay.
Have the payout spread out in two years
The problem with receiving your severance pay in bulk is that it will likely put you in a new tax bracket, which means that you will end up owing a huge amount of money to the IRS in one year. You can avoid this problem by having the amount spread across two years, which will reduce the chances of a tax bracket change.
Put the funds in a donor-advised fund
This will allow you to support an organization of your choice while also reducing the taxes that you would be required to pay on your severance pay. Donor-advised pay will also enjoy tax benefits.