Severance Package Financial Planning

Why severance creates a sudden-wealth planning problem

Severance pay at the executive or senior-professional level often runs $200,000 to $1 million or more — a one-time cash event that puts someone in an unfamiliar financial position they have 60 to 90 days to navigate while also managing the emotional disruption of a job change.

What makes it harder than other windfalls:

• The money arrives alongside a set of simultaneous deadlines — insurance, equity, estimated tax — all running on independent clocks
• Future income is uncertain; the severance may need to serve as a bridge for 6 to 18 months
• High earners are unlikely to have been in this situation before and may not know what they don't know
• Non-compete agreements, often required to receive enhanced severance, restrict which industries or roles are available next
• Equity compensation — ISOs, RSUs, unvested shares — may partially vest, expire, or convert at termination

A financial advisor who works with sudden wealth can help separate what must be decided now, what should wait until you can think clearly, and what should never happen until there is a written plan. The highest-risk period is the first 90 days.

What's typically in a large severance package

Most executive or senior-professional severance packages include some combination of:

• Cash severance — often 1 to 3 months of base salary per year of service, or a fixed lump sum, paid in a single check or on a schedule
• Benefits continuation — COBRA coverage or employer-paid health coverage for a defined period
• Accelerated vesting — some or all unvested equity vests at termination, depending on the plan's change-of-control and termination provisions
• WARN Act pay — if the employer covered by the federal WARN Act (100 or more employees) provides pay in lieu of the required 60-day advance notice, this is taxable ordinary income¹
• Outplacement services — common in packages but rarely financially significant
• Non-compete and non-solicitation agreements — accepted in exchange for the enhanced payout; state enforceability varies

Some packages also include continued 401(k) contributions through year-end or a prorated bonus payout. These should be negotiated explicitly if they are not offered in the initial term sheet.

Tax treatment: the 22% withholding gap

Severance pay is ordinary income — not capital gains, not a personal injury exclusion, not tax-free. It is subject to federal income tax, state income tax, and FICA (Social Security and Medicare) up to the applicable wage bases.

Federal law requires employers to withhold at the supplemental wage rate of 22% on the first $1 million in supplemental wages in a calendar year (severance, bonuses, commissions, and any other supplemental pay combined).² Above $1 million in supplemental wages, mandatory withholding jumps to 37%.

For most high earners, 22% is a significant underpayment. If your ordinary income — wages earned earlier in the year plus severance — puts you in the 32% or 37% federal bracket, the IRS will expect the difference at filing. If you haven't made estimated tax payments to cover the shortfall, you'll owe underpayment penalties on top of the tax bill.

The safe harbor for avoiding underpayment penalties is the lesser of 90% of the current year's actual tax liability or 100% of the prior year's tax liability. For filers with adjusted gross income above $150,000, the prior-year safe harbor increases to 110% of the prior year's liability.³

If you anticipate a large shortfall, make a Q3 or Q4 estimated tax payment before December 31 to close the gap. Your former employer will issue a W-2 showing the supplemental withholding; the balance is due at filing in April unless pre-paid.

Health insurance: COBRA vs. the ACA marketplace

Losing employer-sponsored coverage creates two options with overlapping enrollment windows — and missing the window is costly.

COBRA lets you keep your existing plan for up to 18 months. The cost is 102% of the full plan premium — both your employee share and the employer's share, plus a 2% administrative fee.⁴ For a family plan, this typically runs $2,000 to $2,800 per month or more. It is expensive, but preserves your existing provider network, deductible progress, and any in-progress care.

ACA marketplace allows you to enroll outside open enrollment via a Special Enrollment Period within 60 days of losing coverage.⁵ Premiums may be lower, and if your income drops significantly during the transition year, you may qualify for the premium tax credit. The tradeoff: new network, new deductible, possible coverage gap if timing doesn't align.

The 60-day ACA window starts when your employer coverage ends — not when you receive the severance check. After 60 days, you cannot enroll until the next open enrollment period (November 1 through January 15). Do not let this deadline expire undecided.

Stock options: the 90-day ISO clock

If you hold incentive stock options (ISOs), termination starts a 90-day clock. To preserve ISO treatment — the ability to eventually pay long-term capital gains rates rather than ordinary income rates on the gain — you must exercise within 90 days of your termination date.⁶ After that, the options automatically convert to non-qualified stock options (NSOs) and lose the favorable tax treatment.

The decision is complicated by two factors:

• Cash outlay without proceeds: exercising ISOs requires paying the strike price in cash with no guarantee of near-term liquidity, especially if the company is private
• AMT exposure: the spread (fair market value minus strike price) at ISO exercise is an AMT preference item in the year of exercise. In 2026, the AMT exemption is $90,100 (single) and $140,200 (MFJ); the phaseout begins at $500,000 (single) and $1,000,000 (MFJ).⁷ Exercising large ISOs in a high-income year — like a severance year — can create significant AMT exposure

For a detailed walkthrough of ISO/NSO mechanics, AMT modeling, and concentrated-position diversification, see our equity windfall planning guide.

RSUs are simpler: they vest at termination according to the plan's termination provisions, and any that vest are ordinary income in the year of vesting. No 90-day election and no AMT complication.

401(k): final contributions and rollover decision

Your ability to make pre-tax or Roth 401(k) deferrals ends when your employment ends. The 2026 employee deferral limit is $24,500 (plus $8,000 catch-up for ages 50+; plus $11,250 for ages 60–63 under SECURE 2.0's super-catch-up provision).⁸ If you haven't reached your deferral limit before termination, remaining capacity is forfeited for the year — you cannot contribute to a former employer's plan after separation.

For the existing 401(k) balance, you have several options:

• Leave in the former plan — permissible if the balance exceeds the plan minimum (typically $5,000). May offer lower-cost institutional funds unavailable in an IRA.
• Roll to a new employer's 401(k) — straightforward once you start a new job; preserves retirement account protections.
• Roll to a traditional IRA — broadest investment flexibility; enables future Roth conversion planning.
• Convert to a Roth IRA — creates a taxable conversion in the year of rollover. In a low-income year (gap year with no other income), this can be strategically valuable — you fill the lower brackets with converted funds at rates you may not see again.

Do not take a cash distribution unless you have no other option. Any amount not directly rolled over is subject to 20% mandatory withholding plus ordinary income tax, plus a 10% early withdrawal penalty if you are under age 59½.

IRMAA lookback: the two-year shadow of a high-income year

Medicare Part B and Part D premiums are income-adjusted via IRMAA. The adjustment uses MAGI from two years prior. A high-income year from severance in 2026 affects 2028 Medicare premiums.

The 2026 IRMAA first tier begins at $109,000 MAGI (single) and $218,000 (MFJ).⁴ Above that threshold, Medicare Part B surcharges add $450 to over $4,300 per year depending on income. For executives in their late 50s or early 60s who plan to retire within two to five years, a severance year that pushes MAGI to $400,000 or more can mean meaningfully higher Medicare premiums starting in year three.

Strategies that reduce the MAGI spike in the severance year: charitable donations via a donor-advised fund, delaying the sale of appreciated investments, and maximizing deductible retirement contributions before year-end. The magnitude of the IRMAA surcharge is rarely decisive — but it adds to the case for modeling the full-year income picture before making large, discretionary taxable events happen in the same year as severance.

Income gap planning: how long does the severance need to last?

A non-compete accepted in exchange for enhanced severance restricts your ability to earn comparable income in your industry for a defined period — typically 6 to 24 months, depending on state law and the agreement's scope. The financial planning question is whether the after-tax severance, plus any other savings, covers the income gap at your current lifestyle until you are re-employed at comparable compensation.

A practical framework:

1. Model the gap — post-tax severance minus living expenses per month, multiplied by expected months to comparable reemployment. High earners who have never searched for a role at their income level often underestimate this: a realistic target is 9 to 18 months for a comparable senior role, not 60 days.
2. Build the tax reserve first — before anything else, model the estimated tax shortfall and set aside cash to cover it. A $600,000 severance before taxes may be $360,000 to $400,000 after federal and state tax. Plan with the net number.
3. Fund the income bridge — keep 12 to 18 months of living expenses liquid in high-yield savings or short-term Treasuries before investing any remainder.
4. Invest what remains — only after the tax reserve and income bridge are funded is the remainder truly investable capital. See our windfall investment strategy guide for a deployment framework.

First-90-day action checklist

When to work with a financial advisor

Not every severance requires a financial advisor. A $40,000 package for someone with stable income, good health insurance options, and no equity compensation is manageable without one.

A specialist becomes most valuable when:

• Total package value exceeds $250,000 — the estimated tax math and investment deployment decisions are material enough to justify the cost of getting them right
• You hold ISOs, NSOs, or significant unvested equity with a 90-day clock
• Your income will spike far above your normal bracket in the severance year — creating a window for Roth conversions, DAF contributions, or other year-specific planning
• You are within 5 years of retirement — the severance year is also a Roth conversion opportunity and an IRMAA planning year that has a two-year forward shadow into Medicare
• The package includes installment payments, deferred compensation, or complex equity that requires multi-year modeling

A fee-only advisor who works with sudden wealth events can build a written tax, cash, investment, and income-gap plan before irreversible decisions are made. See our guide to finding a sudden wealth advisor for what credentials to look for and questions to ask.

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