Severance Windfall: Investing For The Future

Severance pay is a form of compensation that a company may offer to employees that it lays off. It can include a lump sum or a series of payments, as well as other benefits such as continuing insurance coverage. Severance pay is not required by law and is usually based on the length of employment. It is important to note that severance pay is typically only offered to employees who are being let go involuntarily.

There are various ways to invest your severance pay wisely. Firstly, it is recommended to do nothing with the money for at least a month to avoid making impulsive decisions. During this time, you should assess your financial situation by creating a spreadsheet of your spending and calculating your income streams. This will help you determine how long your severance pay can sustain you. You may also want to consider hiring a financial advisor to help you make the most of your money.

Another important step is to decide on your future path. Do you want to look for a new job, start a business, or travel the world? Your severance package gives you the time and financial cushion to plan your next steps carefully. It is also crucial to make your money work for you by investing it in vehicles that match your risk tolerance. This could include putting your money in a savings account, investing in the stock market, or starting your own business.

Remember to expect the unexpected and keep some money aside for emergencies. Finally, don't forget to treat yourself a little! You could use a small portion of your severance pay to go on a vacation or buy something you've always wanted.

Pay off high-interest debt

If you've received a severance package, you might be wondering how to make the most of it. One of the best ways to use this money is to pay off any high-interest debt you may have. This is because high-interest debt can be incredibly costly, and the longer it's left unpaid, the more quickly the costs will grow.

High-interest debt is usually considered to be any debt with an interest rate of 8% or more. Credit cards, personal loans, and private student loans tend to fall into this category. For example, many personal loans have interest rates between 10% and 29%, while credit cards often have interest rates between 15% and 30%.

The high interest rates on these types of debt can increase the overall cost of borrowing money and make it more challenging to pay off what you owe. Compound interest, which is common with credit card debt, can cause your balance to grow quickly and make it more difficult to manage over time.

If you're carrying high-interest debt, consider the following strategies to pay it off:

• Make more than the minimum monthly payments. Paying only the minimum on your credit card balances will reduce your overall debt but will cost you more in interest in the long run. Aim to pay more than the minimum each month to make a bigger impact on what you owe.
• Use the debt avalanche repayment method. This method involves ranking your debts in order of interest rate and focusing on repaying the debt with the highest interest rate first. Once that debt is paid off, move on to the debt with the next-highest interest rate, and so on. This approach can help you save money in the long run by reducing the amount of interest you pay over time.
• Consider debt consolidation. If you have multiple sources of high-interest debt, consolidating them into a single new loan with a lower interest rate and more favourable repayment terms can make it easier to manage your debt. Just be sure to research your options carefully and ensure that the new loan will save you money in the long run.
• Use a balance transfer credit card. These cards allow you to transfer your unpaid balance to a new card with an introductory period of up to 21 months of interest-free payments. This can give you some breathing room to make a dent in your debt. Just be sure to have a plan to pay off the balance before the introductory period ends to avoid the card's APR.
• Refinance your debt. If your credit score has improved since you took out the loan, you may be able to refinance with a different lender to get a lower interest rate. This is especially useful for private student loans, which often have high interest rates.

Remember, it's important to get advice from a financial professional to ensure you're making the best decisions for your personal situation.

Put it into a retirement account

Severance pay can be a financial lifeline after losing your job, and it's important to make the most of it. One way to do this is to put it into a retirement account. Here are some reasons why this could be a good option for you:

Tax Benefits

Severance pay is taxed as ordinary income, so one way to reduce your tax bill is to direct it into a tax-advantaged retirement account. This could be an individual retirement account (IRA) or a 401(k) plan, which allow your savings to grow tax-free for many years. In 2024, you can contribute up to $7,000 to an IRA ($6,500 in 2023) with an additional $1,000 catch-up contribution if you're over 50. For 401(k) plans, the limit is $23,000 in 2024 ($22,500 in 2023) with the same catch-up contribution option. By taking advantage of these accounts, you can reduce your tax burden and boost your retirement savings.

Employer Matching

If you're still employed, your employer may match your contributions to your 401(k) plan, which is essentially free money. This is a great way to boost your retirement savings even further. For example, if your employer matches your contributions up to 5% of your salary, you can contribute that amount to get the full company match. This immediately boosts your savings and is a very effective way to save for retirement.

Compound Interest

The earlier you start saving for retirement, the more time your savings have to grow through compound interest. Even if you're just starting with a small amount, the power of compound interest over time can help your savings grow significantly. This is especially beneficial if you're many years away from retirement, as it gives your money more time to grow.

Peace of Mind

Retirement accounts are a great way to save for the future and ensure you have financial stability in your golden years. By putting your severance pay into a retirement account, you're taking a proactive step towards securing your financial future. This can give you peace of mind and reduce the stress of worrying about retirement savings.

Long-Term Focus

Retirement accounts are designed for the long term, and by putting your severance pay into one, you're committing to a strategy that will benefit you in the future. This long-term focus can help you stay disciplined and avoid the temptation to spend the money on short-term desires.

Before deciding how to allocate your severance pay, it's always a good idea to consult a financial professional who can advise you based on your personal situation. They can help you understand the tax implications and ensure you're making the most of your money to secure your financial future.

Invest in a donor-advised fund

A donor-advised fund (DAF) is a unique way to offset the taxes you'd pay on your severance while supporting your favourite organisation. DAFs are sponsored by national charitable organisations and hold your contributions, letting them grow for future distributions or grants. DAFs are a type of charitable giving vehicle that requires a specialised approach to strategic asset allocation decisions.

• DAFs are maintained and operated exclusively by a section 501(c)(3) nonprofit organisation, also known as the sponsoring organisation. Once you make a contribution, the sponsoring organisation has legal control over that contribution, while you retain advisory privileges regarding the distribution of funds and the investment of assets in the account.
• The advantage of this type of charitable vehicle is that the sponsoring organisation handles the investment, administrative, and compliance responsibilities, as well as the associated costs. However, while you retain advisory privileges, you are giving up ultimate control of the assets.
• When contributing to a DAF, you can claim a tax deduction in the year you make the contribution, rather than waiting until the funds are distributed to the charity. This can provide a larger deduction in a single year, which may be more valuable than smaller annual deductions.
• You won't pay capital gains taxes on assets you put into a DAF, and you can usually deduct the current market value of the asset rather than what you originally paid for it.
• DAFs offer anonymity, allowing you to withhold your identity if you prefer not to be solicited for future donations or have your donations become public knowledge.
• When contributing to a DAF, you can donate various kinds of assets, such as cash, stocks, bonds, mutual fund shares, money in IRAs and 401(k)s, and private company stock.
• You can contribute cash or set up automatic donations from your bank or brokerage account at regular intervals to gradually increase the amount available for investment.
• If you have a high-performing stock that you'd like to donate but also keep in your portfolio, you can donate it to a DAF and then purchase new shares of the same security. This will give you a higher basis than the original, minimising future tax liability if you decide to sell.
• If you're expecting a large sum of money, such as a severance package or business exit, consider using a DAF to offset higher-than-normal income years with larger-than-normal donations.

Put it towards health expenses

Severance pay is given to employees by their company when their employment is terminated. It is a form of compensation that aims to ease the financial blow of job loss and acknowledge the employee's contributions to the company. It is taxed as ordinary income, and while there is no way to completely avoid paying taxes on severance pay, there are ways to reduce the amount that will be taxed. One way to do this is to put your severance money in a health savings account (HSA) if you have a high-deductible health insurance plan (HDHP). This is a great way to plan for future expenses if you don't want to put the money toward retirement.

The conditions for an HSA are as follows:

• You can save as much as $4,150 for self-coverage or a maximum of $8,300 for a family plan.
• Your deductible must be $1,600 for self-coverage or $3,200 for family coverage.
• Your out-of-pocket expenses are limited to $8,050 (self-only) or $16,100 (for family coverage).

Additionally, you can use your severance pay to cover any medical or dental expenses that are not reimbursed by insurance. These expenses are tax-deductible within certain limits. For example, taxpayers with group health insurance coverage are generally not allowed to deduct medical expenses. Only those who itemize their deductions are eligible to claim any medical expenses, and only those expenses that exceed 7.5% of the taxpayer's adjusted gross income (AGI) can be deducted. Deductible medical expenses may include but are not limited to:

• Payments to doctors, dentists, surgeons, chiropractors, and other non-traditional medical professionals.
• Payments for inpatient hospital care or residential nursing home care.
• Payments for weight-loss programs, smoking cessation programs, acupuncture treatments for addiction, or prescription medication.
• Payments for prescription eyeglasses, contact lenses, hearing aids, wheelchairs, guide dogs, or other items purchased to aid physical disabilities.
• Payments for transportation to medical care facilities, including the standard mileage rate, gas, tolls, parking, taxi, bus, or train fare, and ambulance costs.

Remember to always consult with a financial professional to get the best possible tax benefits for your personal situation.

Do nothing for a month

If you've just received a severance package, you might be wondering what to do with the money. While there are many options for investing your severance pay, it's also perfectly valid to take some time to consider your options. Here are some reasons why doing nothing for a month after receiving your severance pay may be a good idea:

Take time to process the change

Losing your job can be a stressful and emotional experience. Taking a month to process your feelings and adjust to your new situation can help you make more rational and thoughtful decisions about your future plans and financial situation. It's important to give yourself time to come to terms with the change and assess your options without rushing into any decisions.

Assess your financial situation

Before making any major financial decisions, it's crucial to understand your current financial position. Take stock of your assets, liabilities, income sources, and expenses. This will help you identify your short-term and long-term financial needs and goals. During this month, you can create a budget that reflects your new circumstances and helps you make informed choices about how to allocate your severance pay.

Research your options

There are numerous options for investing your severance pay, each with its own advantages and disadvantages. By taking a month to research and understand these options, you can make a more informed decision about which investment strategies align with your financial goals and risk tolerance. This includes exploring different types of investments, such as stocks, bonds, mutual funds, or real estate, as well as considering tax-efficient investment vehicles like retirement accounts or health savings accounts.

Seek professional advice

Consider using this month to consult with financial advisors or planners who can provide personalized advice based on your unique circumstances. They can help you navigate the complexities of investing, offer guidance on tax implications, and develop a comprehensive financial plan that maximizes the impact of your severance pay. Seeking professional advice can help you avoid costly mistakes and ensure that your investments are aligned with your short-term and long-term goals.

Focus on self-care

Job loss can be a challenging and stressful experience. Taking a month to focus on self-care and personal well-being can help you stay resilient and positive during this transition. Use this time to recharge, reflect, and prioritize your physical and mental health. Engaging in self-care activities, such as exercise, meditation, or hobbies, can provide a sense of stability and help you approach future job searches or investment decisions with renewed energy and clarity.

Remember, there is no one-size-fits-all approach to investing your severance pay. Taking a month to pause and evaluate your options can help you make informed and thoughtful decisions that align with your financial goals and personal circumstances.

Frequently asked questions