The COVID-19 pandemic, which has kept many workers home, was a kind of test drive for retirement: You learned what it’s like to stay out of the office for long periods of time. But many companies are hurting because of the economic turmoil from the coronavirus, and if you’re 50 and older, and your employer needs to cut costs, they may be looking at cutting you from the payroll.
Sooner or later, you may be staring at an early retirement package. As enticing as taking the deal might seem, it’s a decision that should be made only after analyzing it carefully. What the early retirement decision boils down to is: “Can I afford to do it?” says Brad Hindman, CFP (Certified Financial Planner), a financial advisor at Wells Fargo Advisors.
Do the math
Most early retirement packages include salary severance (such as receiving one or two weeks’ pay for each year of service); extended health insurance coverage; and pension-related payout. But just because you’re offered an early retirement package, it doesn’t mean you have to retire if you take it.
Your first question is whether you’d consider working after taking your company’s early retirement offer. Taking a voluntary buyout when you plan to keep working is a far different decision than if you’re considering retirement. “Is this the end of the road … where I stop working, or do I take the buyout and keep working?” is an important question to answer, says Rob Leiphart, CFP, vice president of financial planning at RB Capital Management. After all, if you have a new job lined up, you’ll still be collecting a paycheck after the buyout, and you could put some extra savings in the bank. If your job prospects are good, taking early retirement can be a win-win.
But the number-crunching gets more difficult when your future job prospects are poor, or you’re planning on using the voluntary buyout as an off-ramp from work.
How close are you to retirement?
The older you are — and the closer the early retirement package offer is to your planned retirement date — the better, says Nick Foulks, director of advising at Great Waters Financial. Let’s say you’re 63 1/2 when you get a buyout offer. Assuming you’ve got adequate savings, a well-stocked 401(k) or IRA retirement plan, and no large debts or upcoming big-ticket purchases, you’re “within the window” to accept the buyout.
Why? Because you’re just 18 months away from being eligible for Medicare health insurance at age 65. The Consolidated Omnibus Budget Reconciliation Act (COBRA) gives workers the right to continue their employer-based health coverage for up to 18 months, even if their termination is involuntary, and most early retirement packages offer COBRA benefits. Although you have to pay for COBRA out of your own pocket, the coverage will act as a bridge to age 65 when your Medicare coverage kicks in.
It’s not cheap. You’ll be charged 102 percent of your employer’s cost for health insurance. (Employers usually pay a large share of employees’ health insurance premiums). A better, potentially cheaper option to acquire health coverage is joining your spouse’s plan, if he or she is employed and has a plan at work. You can also shop for your own private plan through the federal government-run Health Insurance Marketplace. But don’t roll the dice and try to go without health care. “It is essential to have access to affordable health care,” says Philip Herzberg, CFP, a client advisor with the Lubitz Financial Group. That’s even more true if you’re single or the sole breadwinner in your household.
How will you make ends meet?
Retiring works best when you have enough sources of income to pay your monthly bills, well, forever. “How will you replace your paycheck?” says Foulks. “Your paycheck may stop, but the bills don’t.”
Now’s the time to do an expense audit and figure out what your monthly costs are now and what they will be in the future. Are there any big-ticket purchases that you still need to fund, such as college tuition? Any big outstanding debts?
Once you gather your expense numbers, see if you’ve got enough income or assets to cover it all. Combine your balances from all your different accounts, including savings, retirement plans, other pensions, the buyout offer, Social Security and any other sources, to calculate how large an income stream you can generate. Keep in mind that most retirement plans, like a 401(k), penalize you if you make withdrawals before age 59 1/2. Now’s also the time to figure out which accounts to pull from first and how to draw down your savings in the most tax-efficient way.
As a general rule, you’ll want to replace 80 percent of your income in retirement, says Wells Fargo’s Hindman: “If you made $5,000 a month after taxes when you were working, where will that money come from in retirement?” If you don’t have enough assets to make up the income gap, think about what compromises you’re going to have to make.
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Analyze whether the buyout terms are rich enough to allow you to leave your job and bridge the income gap until retirement age of 65 or until you get a new job. If not, you might be better off not taking it. A severance payment of six months to a year might give you enough time for a new job; for most people, a month or two of severance won’t.
Even if you do get a large severance payment, don’t get blinded by a big check. It’s there to tide you over until you get a new job, or to help pay your expenses in retirement. “A lot of people get a one-time lump sum of $100,000 and get excited over the lure of a shiny big number,” says Leiphart. “They treat it like gambling winnings. Instead, they should use the lump sum to seed their future. Often, it gets spent and never gets time to germinate.”
And don’t forget that any lump sum you receive will be subject to taxes. If the lump sum comes near the end of the year, after you’ve already earned a large part of your salary, it could also push you into a higher tax bracket and cost you even more in taxes, Hindman cautions. If possible, try to get your employer to spread out your payout over multiple tax years to reduce your tax bill.
Is it too risky to take a buyout?
You can’t let magical thinking or the size of a buyout blind you to the realities of your situation, Foulks says. You need to know if your combined savings and Social Security will let you manage your lifestyle without a 9-to-5 job. “You don’t have a magic wand to make money appear,” Foulks says.
The state of the economy and job market are two other wild cards to consider when deciding whether to take an early retirement package, Hindman warns. “One risk is if you don’t take the buyout and you end up getting terminated at a later date anyway,” Hindman says. “The second gamble is if you take the early retirement package with the intent of getting another job, and you don’t get it.”