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Taxing Problems: Two steps to a tax-free severance rollover

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in Firing,Human Resources

Q. My job was eliminated as of Dec. 31, so I’ve decided to retire. I’m over 60 and have a 401(k).I’m also entitled to receive lump-sum severance and a deferred bonus in January. Can I roll over those payments to an IRA? A.A., Houston

A. You can’t roll over compensation—such as wages, bonuses and severance payments—tax free to an IRA or other qualified plan. But you can effectively accomplish the same result, within limits,through a two-step process. Here’s what you can do, but you have to act quickly:

1. Arrange to have the payroll department treat the payments as salary deferrals to your 401(k) plan. For 2006, you can defer up to $20,000 to the plan ($15,000 regular contribution plus a $5,000 “catch-up contribution”for taxpayers age 50 or over).

2. Roll over your 401(k) plan account balance,including your 2006 deferral of up to$20,000, to your IRA. There’s no tax if the rollover is completed within 60 days.

If there’s any cash left over (i.e., the severance and bonus exceed $20,000), you can contribute up to an additional $5,000($4,000 regular contribution plus $1,000catch-up contribution) directly to an IRA for the 2006 tax year

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