Losing a job: severance, unemployment, the 401(k) and health coverage

Severance, accumulated vacation and unemployment benefits are all taxable income. The decisions that follow a layoff differ mostly in how much tax comes out now and how much waits until you file.

Severance and the last paycheck

A layoff package is income. Severance counts, unemployment compensation counts, and so does whatever the employer pays out for vacation or sick days you never used. None of it is a settlement or a gift as far as the return is concerned; it is money you earned, and it lands where your wages landed.

What to do about that is a decision, and it is better made now than in April. Make sure enough tax is being withheld from any severance still to be paid, or plan an estimated payment for the quarter it arrives. The gap is much easier to close while the money is still in the account.

Severance is often run through payroll as a supplemental wage, which is why the tax taken out of it can look nothing like the tax taken out of your old salary. Are bonuses taxed higher works through that rate and why it is not the tax you finally owe.

Unemployment is taxable, and usually untaxed on arrival

You generally have to include all the unemployment compensation you receive in income. What produces the April surprises is that nothing comes out of it on the way unless you ask.

The state agency reports what it paid you on a Form 1099-G. Box 1 carries the compensation, box 4 carries any federal income tax that was withheld, and the box 1 amount goes to Schedule 1 with the rest of your additional income. Form 1099-G walks through the boxes.

There are two ways to close the gap before it opens. You can ask for federal income tax to be taken out of the benefit by filing Form W-4V, Voluntary Withholding Request, which holds back 10% out of each payment. Or you can make quarterly estimated payments instead, which quarterly estimates covers.

The 401(k): three doors, one of them expensive

The plan will ask what you want done with the balance. There are three answers, and they cost wildly different amounts.

Door one is to leave the money where it is, or move it directly. A direct rollover into another employer's plan or into an individual retirement arrangement avoids withholding entirely, and a check made payable to the receiving plan rather than to you is not subject to withholding either.

Door two is to take the money and intend to roll it over afterwards. A plan distribution paid to you carries mandatory withholding of 20%, even when you fully intend to move it. You then have sixty days to complete the rollover, and to roll the whole amount over you have to make up the withheld part from other money. Whatever you do not replace is treated as a distribution you kept.

Door three is to cash out. What you keep is taxable, and an additional 10% applies to an early distribution unless one of the exceptions fits. Cashing out a 401(k) early sets out those exceptions, and Form 1099-R is the form the plan sends either way.

Health coverage: COBRA or the marketplace

You may be eligible for COBRA continuation coverage if your former employer offers it, which lets you keep the plan you already have. If you take it you pay the whole premium, including the share the employer used to cover, plus a small administrative fee. That is why a plan that felt cheap as an employee rarely feels cheap as a former one.

The marketplace is the other route, and it prices its help differently than people expect. What you qualify for there turns on two things: how many people are in the household, and what you expect to earn across the coverage year. Whether you are working is not one of them, so the income figure you give is what decides the help you get.

Tell the marketplace about a new job and about any change in income right away. That keeps the amount of help correct and stops a balance coming back at you when you file. Marketplace insurance for 2026 covers what changed in the credit, and Form 1095-A is the form that reconciles it.

What a low-income year does to your return

There is one piece of good news in this. A year with several months of no wages can drop a household under limits it has always been above, so credits that were never available before may be this time. The earned income tax credit and the child tax credit are the two that move the most money, and each sets out who qualifies.

The same year can make itemizing pointless, because a shrunken list of deductions rarely beats the standard deduction. That is a saving in effort rather than in tax, but it is worth knowing before you go hunting for receipts.

What to do in the next two weeks

Set the withholding on any severance still to be paid. Request withholding on the unemployment benefit, or put the next estimated payment in the calendar. Leave the retirement money alone until the receiving account exists and the rollover paperwork is in hand, because door two only becomes expensive once the check is written. And give the marketplace a realistic income estimate for the rest of the year rather than the salary you were on in January.