The Severance Negotiation Move That Cut a 56-Year-Old VP’s Tax Bill on Her $480,000 Package by $112,000

When executives negotiate severance packages, most focus on the number. They want to know how much they’ll be paid after their years of service, and the rest of the details can be less meaningful.

But if you receive a severance package, it’s important to negotiate the terms. This especially holds true if it happens in your mid-50s.

How one VP scored a big tax win

Recently, Marsha was let go in a corporate restructuring. Losing her executive role at 56 wasn’t particularly devastating for her, as she’d been contemplating early retirement anyway. And a stealth move on her part helped her save a bundle of money on her severance package.

Severance pay is taxable as ordinary income. And depending on where you live, you may be looking at a double whammy — high federal taxes and high state taxes on your exit package.

Instead of accepting a lump-sum payment of $480,000, Marsha instead negotiated a structure that spread her payment out. Instead of taking the full payment immediately, her deal split the severance into two separate tax years — $240,000 paid in 2026 and the remaining $240,000 paid in 2027 after retirement.

As someone with a tax-filing status of married filing jointly, Marsha’s severance would’ve bumped her into the 37% tax bracket had it all been paid in 2026. That’s because the entire $480,000 sum would’ve been added to her ordinary salary plus her husband’s salary.

Instead, Marsha managed to stay in the 35% tax bracket in 2026 and expects to be in the 24% tax bracket in 2027, since she won’t be working. As a result, she anticipates saving about $112,000 in taxes.

The fact that Marsha negotiated a deferred payment is crucial, too, because under the IRS constructive receipt doctrine, if someone has unrestricted access to income, it’s taxable that year.

In other words, Marsha could not just decide to receive a lump sum and pay taxes on it over time. Rather, her employer had to expressly offer the deferred payment as part of the agreement.

The rule of 55 adds another layer

There was another important factor Marsha addressed in her severance negotiation — preserving early access to her 401(k) plan.

The rule of 55 allows workers who leave their employer during or after the year they turn 55 to take penalty-free withdrawals from that employer’s 401(k) plan before age 59 and 1/2. However, the timing and wording of severance agreements can sometimes create confusion around separation from service.

The trigger of the rule of 55 is generally the actual separation from employment — not when severance payments are made. But it’s important for severance documents to be worded carefully to avoid confusion.

Now, Marsha can tap her 401(k) prior to age 59 and 1/2 if she so chooses. She may not need to do so right away since she has a huge amount of severance coming her way this year and next. But she has more flexibility a couple of years down the road.

Know the rules and negotiate carefully

All of this underscores the importance of tax awareness and planning in the context of a severance agreement. If you’re about to get a buyout, you may want to consult a tax professional beforehand so they can help you negotiate a deal that offers crucial IRS savings.