Is Severance Pay Eligible for IRA Contributions?

by D. Laverne O'Neal, Demand Media

    When you're laid off from a job, one of the parting comforts is your severance pay. Even if you weren't with the employer for long and the amount is minimal, that extra sum makes you feel that your time with the company counted for something. Since you might not have a high-flying income for awhile -- and because many other forms of income cannot be contributed -- an IRA can be a good place to park your severance money. Because severance pay is reported to the IRS as salary, it is eligible for contribution to an IRA.

    Earned Income

    The IRS stipulates that individual retirement accounts be funded with earned income. This can include wages, salaries, commissions, tips, self-employment income and military pay. Even taxable alimony is considered earned income.

    Severance Pay

    The IRS classifies severance pay -- money paid to you when you separate from your employer -- as earned income. As further evidence, severance pay is included in Box 1 of Form W-2 -- the box that includes wage and salary income -- which you receive from your employer each January. Consequently, severance can be put in an IRA.

    Unemployment Income

    Unemployment compensation, however, cannot be contributed to an IRA. If unemployment benefits represent your sole income, you may still be able to put money in an IRA if your spouse has earned income for the year and you file your taxes jointly. Your spouse can contribute on your behalf the lesser of your combined earned income or $5,000. Moreover, if you contribute to a traditional IRA, you can deduct some or all of the contribution if your modified adjusted gross income as of tax year 2012 is less than $112,000. If your tax-filing status is married filing jointly, the upper MAGI limit to put money in a Roth IRA, as of 2012, is $183,000.

    Other Types of Income

    You cannot contribute interest, dividend or rental income to an IRA. The same goes for workers compensation, disability, social security, pension or annuity income. Foreign earned income is also excluded. The IRS does not consider these income types as earned income.

    About the Author

    D. Laverne O'Neal, an Ivy League graduate, published her first article in 1997. A former theater, dance and music critic for such publications as the "Oakland Tribune" and Gannett Newspapers, she started her Web-writing career during the dot-com heyday. O'Neal also translates and edits French and Spanish. Her strongest interests are the performing arts, design, food, health, personal finance and personal growth.