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 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 $1,000 catch-up contribution) directly to an IRA for the 2006 tax year.