Sep 3 2025
Amanda DeMatteis: Hi, Josh.
Josh Goodbaum: Hi, Amanda. What are we talking about today?
DeMatteis: Well, as you know, we do a ton of severance agreement work with employees who are leaving their employers for various reasons, and a question we often get from Connecticut employees is: “Can I put some of the severance amount that my former employer is paying me back into my 401(k)?” What do you think?
Goodbaum: Usually not, Amanda. So, we’re not tax lawyers, we’re not accountants, we don’t give tax advice, we don’t give financial planning advice, but we do represent a lot of employees in severance negotiations, as you say, and this does come up a fair amount.
The reason people want to take money from their severance and put it in their 401(k) is they don’t want to pay taxes on it right now. They want to pay their income taxes later. But that kind of tax deferral scheme comes with a whole bunch of strings, according to the Internal Revenue Code and the IRS‘s implementing policy guidance.
One of those strings is that the money you put into a 401(k) usually has to be money that you have earned as compensation for services that you have provided to your employer. A severance isn’t payment for services rendered; it’s payment for agreeing not to sue your employer and other promises. As a result, it’s often not eligible for allocation to a 401(k) account.
There’s a second reason that it’s usually not possible to put a severance into a 401(k) account, which is that 401(k) plans exist because there is an actual “plan.” It’s a physical document that is written out. It’s very long. It’s very detailed. It is often filed with the federal Department of Labor and/or with a state agency. That plan usually specifies that, in order to participate in the 401(k) plan – that is, to direct income that you would otherwise receive into the 401(k) plan – you need to be an active employee of the company. And once you’re receiving the severance, you’re not an active employee of the company anymore. You’re a former employee of the company. So, you still have a right to what you put in the 401(k) when you were working there, but you no longer have a right to access the benefits of the plan.
Now, it can be possible in certain circumstances to take severance money and redirect it into a 401(k) if the severance is being negotiated before the separation. It is possible, in other words, not to receive a severance when you are no longer an employee, but rather to receive a severance, effectively, during a notice period while you are still an employee of the company, still nominally working for the company, still providing services the company perhaps, and therefore still able to access the 401(k).
Now, even if you can’t put part of your severance into a 401(k), there might be other ways to minimize your tax liability related to a severance, but that’s something that’s really best to discuss with your accountant or with a dedicated tax lawyer.
DeMatteis: These are really useful things to think about if you’re separating from your employer or think you may be separating from your employer sometime in the future, so that you can plan accordingly. Thank you so much, Josh, and thank you for watching. Take care.
Posted by Garrison, Levin-Epstein, Fitzgerald & Pirrotti, P.C. in Commentary
Tagged Amanda DeMatteis, Joshua Goodbaum, Severance Agreements
