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My company will only match my contributions up to 6% of salary, so there is no additional matching benefit for contributing to the IRS limit. I anticipate that it might take me a while to find a new job, so I’m looking to maximize my contribution.

Is my severance pay considered income for IRS income limits on Roth IRA contributions? If I’m below the income limit, are there any circumstances where it would be more beneficial to contribute less to my 401(k) and contribute something to a Roth IRA?

What happens if I contribute the full $22,500 before the end of my old job and then get another job before the end of the year? Is it possible to contribute to a new 401(k) account to get an additional match?

Severance pay strategy

Dear Strategic,

I’m sorry to hear of your impending layoff. Unfortunately, pink is slipping in some industries as recession fears darken the horizon. Many tech workers know this all too well. IBMIBM,
-4.48%,
Lam Research Corp. LRCX,
+1.91%
and SAPSAP,
-1.77%
are just some of the latest big companies that have cut staff.

On the bright side, the tax code has options on where to deploy and hide money amidst these macroeconomic question marks. But this is not necessarily a simple task, especially at this time. “You try to make decisions in the face of uncertainty, and it’s hard,” said Eric Bronnenkant, tax manager at robo-advisor Betterment.

The starting point is a 401(k) contribution limit in 2023 that goes up to $22,500. Catch-up contributions allow an additional $7,500 for workers over age 50. Then there are the income limits for investing in Roth IRAs, which are funded with after-tax money. Individuals must earn less than $153,000 and married couples filing jointly must earn $228,000 to contribute anything to these accounts, according to IRS rules.

The IRS considers severance pay to be a salary supplement, and it is subject to income tax withholding and payroll taxes. “Generally speaking, severance pay counts toward Roth IRA income limits, said Nilay Gandhi, senior wealth advisor at Vanguard – “unless severance pay is specifically excluded by law. employer, and that the employee should ask their employer whether they will be considered taxable income or not.”

Even if salary, plus severance, puts you out of the game for direct Roth IRA contributions, Bronnenkant noted that you might still have the potential option of a “backdoor” Roth IRA conversion, despite your income.

You ask how much you can contribute to a new 401(k) plan if you have already maximized contributions at your current employer. The answer is $0, Bronnenkant said, because the IRS won’t allow people to add more money to a new plan after reaching the maximum annual contribution limit elsewhere. “In particular, what is not aggregated are employer contributions,” he said.

There’s nothing stopping the new employer from making their own contributions in 2023 to your brand new 401(k) account, even if you can’t add more for the year, Gandhi said.

It’s something to ask potential employers, said Gandhi. “That’s why the rules of the regime are so important here. The plan rules will govern employee contributions and what the employer will do as well,” he said. There’s more on the rules surrounding employer contributions from MarketWatch investment columnist Beth Pinsker here.

Then there’s your question of whether there are scenarios where putting less money into your current 401(k) and more direct contributions into a Roth IRA is more useful. You could put the whole $22,500 in your 401(k), you say, but you want to know if you should.

Withholding 401(k) contributions may eventually give you a chance to get more matching money from the employer into a new account, Bronnenkant said. That’s assuming the new work is coming this year (and I hope it is). “This scenario requires you to have visibility into the future that you may not have today,” he noted.

Pouring more into the Roth IRA could be a way to establish a source of money that serves as a retirement account but also as a savings fund for a possible storm.

“Contributions can be tax and penalty free at any time, so they can also serve as an emergency fund while growing,” Gandhi said.

If withdrawals exceed contributions, taxes and penalties may apply to someone under age 59.5, Vanguard notes. In traditional IRAs, taxes and penalties apply on contribution withdrawals before age 59½, he said.

Among the multitude of economic forecasts for 2023, Vanguard predicts a 90% chance of a recession in the United States. But that would likely be part of a “moderate” global recession, according to the asset management giant’s chief global economist.

This emergency money could turn out to be “of great importance” if it takes some time before the next job happens, Gandhi said.

In March, what will the economy and the job market look like? Is there a soft, even soft landing? A looming recession? We all want more certainty. “You make the best decision you can with the information you know at the time,” Bronnenkant said.

A tax question? Email me at: akeshner@marketwatch.com

Thanks for reading. I want to help you think more broadly about the issues affecting your taxes. I don’t offer tax advice, just an attempt to consider what the whirlwind of tax rules and economic conditions might mean for your wallet.

I’m here for the reader who faces his taxes with an air of resignation. You don’t like taxes too much, I understand. I was once that guy. Beneath the jargon, think of your taxes as a maze – with money at the end. Or a trap you need to avoid.