At 63 He’ll Get a $120,000 Severance Check and Want to Shelter It in His 401(k). Most Plans Won’t Let Him, but His Final Paychecks and Unused Vacation Might Count

At 63, he’s at the kitchen table with the severance letter. It’s $120,000, paid in a lump sum. His first thought is to push as much as he can into his 401(k) and dodge the tax. A few seconds later, his second thought comes: that’s a lot of money landing on one year’s tax return.

This is a common situation. Households aged 55 to 69 hold 50% of all defined contribution retirement money in the U.S., according to Federal Reserve data. So plenty of people end up making this exact call in the last few working years.

His Final Paychecks and Vacation Payout May Qualify for the 401(k)

Some pay that arrives after your last day can still count as 401(k) pay. That includes wages and unused vacation or sick time paid with a final paycheck after termination. Severance pay, though, is generally excluded.

There’s a deadline. The money has to be paid by the later of 2½ months after severance from employment or the end of the limitation year that includes the date of severance. For most plans, the limitation year is the calendar year. His plan document must also allow it. Plan administrators also argue about this timing online. One message-board thread asked about pay landing “within the same plan year as the termination, but potentially more than 2 1/2 months after the termination date”.

The 2026 deferral limit is $24,500. In the year someone turns 60, 61, 62, or 63, the plan can allow a bigger catch-up of $11,250 on top of that. The usual catch-up is $8,000. Add it up, and he can defer up to $35,750. One wrinkle: if his Social Security wages topped $150,000 in 2025, his catch-up has to go in as Roth. That means he pays tax on it now.

What That $120,000 Check Really Costs Him

Severance is taxed as wages. Employers usually withhold federal tax at a flat 22% on extra pay like this, rising to 37% on the portion above $1,000,000. On his check, that works out to $26,400 withheld. Payroll taxes take another 7.65%, or $9,180, as long as his total wages stay under the $184,500 Social Security cap.

In 2026, a single filer’s 24% bracket starts at $105,700 of taxable income. If his salary already put him there, the severance gets taxed at 24%, which comes to $28,800. That leaves a $2,400 gap he’ll owe in April, and more if the check pushes him into the 32% bracket. Withholding is only a down payment, and the bill comes later.

Four Moves That Cut the Tax Bill

1. Ask to split the payment across two tax years. Say he gets $60,000 in December and the other half in January. The January half lands in a year with no salary, so more of it gets taxed at lower rates. The catch is health coverage. If he buys a marketplace plan for that year, the $60,000 counts as income, and a single filer loses the premium tax credit entirely once income passes 400% of the poverty line, about $62,600 for 2026 coverage. He should price his coverage before he decides.
2. Max the 401(k) from his last regular paychecks. He should raise his deferral rate now so the paychecks he has left, plus a vacation payout if the plan counts it, get him close to the full limit before he leaves.
3. Fund an HSA if he qualifies. With a high-deductible health plan, the 2026 limit is $4,400 for self-only coverage or $8,750 for family coverage. People 55 and older can add an extra $1,000.
4. Hold Roth conversions until a lighter year. Adding a conversion on top of severance taxes it at his highest rate. A year with no salary and no severance is the cheaper time to convert (that quiet period between a last paycheck and the first required withdrawal is the whole subject of our free Roth Window guide).

Medicare Will Check This Year’s Income

Medicare sets premiums using your income from two years ago. At 63, Medicare will look at the return he files this year when he turns 65. Right now, the first surcharge kicks in above $109,000 for single filers and $218,000 for joint filers. At that level, Part B goes from $202.90 to $284.10 a month. If he gets hit, Form SSA-44 lets him request a recalculation by listing retirement as a “Work Stoppage.”

Health Coverage and Unemployment Come Next

He’s still two years from Medicare, so he’ll need COBRA or a marketplace plan in the meantime. He should price both before his last day. Unemployment rules depend on the state, and some states treat severance differently, so he should check his state’s rules before he counts on benefits.

One Question to Ask HR Before He Signs

Can the severance be paid across two tax years? He should ask before he signs, because changing the timing afterward can run into the deferred-compensation rules in Section 409A. Once he has that answer, the next question is whether the plan lets him defer from his final pay and vacation payout, and when his last regular check goes out.

The mistake to avoid is spending weeks trying to get the severance itself into the 401(k). For most people, the rules shut that door, and the real tax savings come from the paychecks he still has coming.

Contact [email protected] for any questions or corrections.