Is Severence Pay Eligible for IRA Contributions?

by D. Laverne O'Neal, studioD

Severance pay is one factor that can cushion the blow of losing your job. It generally represents pay in lieu of notice and may amount to two or more weeks' compensation, depending on how long you worked for the employer. Though you might reasonably assume it to be earned income, in fact, the Internal Revenue Service does not allow it to be contributed to an IRA account.

Earned Income Defined

The Internal Revenue Service defines earned income to include wages and salaries. The IRS also views commission, tip and self-employment income, as well as taxable military pay and alimony, as earned income.

Severance Pay

Severance pay and other unemployment compensation is not earned income, according to the IRS definition, and therefore cannot be placed in an IRA. Workers compensation, Social Security and disability benefits, and pension and annuity income are likewise not eligible; neither is investment, rental and royalty income.

Contributions Cannot Exceed Earnings

You can put no more money into an IRA than you earn in the relevant tax year. For example, suppose you lose your job as of January 1 and find a new job near the end of the year, and your earned income for the year is $3,000. For that year, you can contribute no more than $3,000 to your IRA.

April 15 Deadline

If, for example, after losing your job early in the year, you find employment in September, you'll likely earn at least the IRA maximum yearly contribution of $5,000 -- or $6,000 if you are 50 or older. However, playing financial catch-up might consume your earnings during that calendar year. Fortunately, you have until April 15 of the following year -- the income tax filing deadline -- to actually make your contribution to the IRA.

About the Author

D. Laverne O'Neal, an Ivy League graduate, published her first article in 1997. A former theater, dance and music critic for such publications as the "Oakland Tribune" and Gannett Newspapers, she started her Web-writing career during the dot-com heyday. O'Neal also translates and edits French and Spanish. Her strongest interests are the performing arts, design, food, health, personal finance and personal growth.

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