You have worked for the company nearly 25 years, rising from a mailroom clerk to an executive with a corner office. Then one day the CEO walks in and says, “Jim! Congratulations! We’re offering you a Golden Handshake.” He shakes your hand, and as he leaves, three human resources executives sweep in to explain to you your retirement package.
Your Retirement Package?
Yes, in today’s corporate environment, cost cutting, restructuring, and downsizing are not only normal, they are expected. Many employers are offering their employees early retirement packages. While many early retirement offers seem attractive at first, it is important for you to review an offer carefully before accepting it to ensure that it is indeed a “golden” opportunity.
An early retirement offer usually includes severance payments and post-retirement medical coverage coupled with already existing retirement benefits. Severance payments are payments that are usually based on the length of employment prior to termination. They may include payment for unused vacation and sick days, and unreimbursed business expenses. Payments can be distributed in either a lump sum or over a number of years. Severance packages often provide medical coverage until you reach age 65 and become eligible to receive Medicare. Some lucrative, executive-level packages may provide full or reduced medical coverage past the age of 65, or may pay all or part of the difference between what you would collect if you retire early and the amount you would earn if you were to continue working.
Your employer may offer you a different type of early retirement in the form of a “bridge payment.” In this scenario, the company provides you with temporary benefits to bridge the period between your early retirement and the time when you are eligible to receive Social Security benefits. These temporary benefits are usually equivalent to the amount you will receive from Social Security at age 62.
When considering an early retirement offer, we believe you should discuss your situation with a financial adviser, and in extreme cases, an attorney. Company-paid consultants may provide valuable information, but they may not necessarily be acting in your best interest. If you are older than 40, under the Older Workers Benefit Protection Act, you must be given 21 days to consider a severance offer.
We suggest first calculating how much you can expect to receive each year after you retire. Then determine the difference between what you should collect if you were to retire early and the amount you should earn if you were to continue working. After you know how much money is on the table, you next need to consider how an early retirement will financially affect all of your retirement years. Your annual living expenses during an early retirement will likely differ from your expenses later in retirement. You may be still paying a mortgage or funding your children’s education. You should consider income from early retirement package, Social Security benefits, personal savings and investments, and wages if you choose to continue working for another employer. If your early retirement package does not include medical coverage, you will need to calculate the cost of health care into your living expenses.
Areas for Consideration
Taxes
In certain cases, severance pay is considered “deferred compensation.” This compensation is subject to the requirements of Internal Revenue Code Section 409A, which applies to compensation that an employee earns in one year, but that is paid in a future year. If the arrangement does not meet the requirements of Section 409A, the compensation could be subject to certain additional taxes, including a 20% additional income tax.
Less Time to Save for Retirement
Leaving the workforce early gives you less time to save; thus, you may have less savings available during retirement. Between a lower retirement age and increasing life expectancies, you could spend as many years in retirement as you did in the workforce. Accepting early retirement could result in a smaller pension. Defined benefit plans, generally, are based on two factors: length of service and salary during your highest earning period. If you accept the offer, your years of service are reduced. Additionally, your highest earning period generally occurs just before retirement. Therefore, you may be giving up your highest earning period.
If you were to accept an early retirement offer, you could be giving up 10 or more years of saving for retirement. According to our Ten Year Rule, any money you need in the next 10 years should be in fixed investments, and money you do not need within the next 10 years should be invested in equities. If you were not planning to retire for many more years, you may need to consult a financial adviser to discuss needed changes to your investments and savings. You must also consider the effect of inflation, which could eat away at the purchasing power of your retirement savings. Inflation has historically averaged 3% annually.
Tapping into Retirement Accounts Early
An IRA or retirement plan can be a valuable source of retirement income; however, the need for current income should be considered carefully. With life expectancies on the rise, you may need to draw on those retirement assets for a long period of time. Taxable distributions from employer-sponsored 401(k)s and traditional IRAs are generally subject to a 10% premature distribution tax if made before age 59½. However, there are a number of exceptions to this rule. If you are 55 or older, you may take distributions from 401(k)s and other qualified plans, as a result of separation from service. Another important exception from the 10% premature distribution tax is for substantially equal periodic payments. IRS rule 72(t) allows you to take advantage of your retirement savings before the age of 59½ by taking a series of substantially equal periodic payments. The withdrawals, however, are still taxed at your income rate.
Overall, you will want to consult a financial adviser or tax consultant to fully understand how much you may owe in taxes if you will begin withdrawing from your retirement accounts early.
Will the Company Continue to Exist?
If you turn down an early retirement offer, you may be able to keep your job; however, there is a possibility of future layoffs. If you think there is a good chance you might be laid off down the road, you may want to accept a sure thing right away rather than face the uncertainty of your company’s future plans. If you’re holding out for a better offer, keep in mind that the first offer is oftentimes the most generous—especially, if the company is downsizing or is being absorbed by another firm.
Will the Company Negotiate?
Oftentimes, employers may sweeten early retirement packages, increasing pension benefits beyond what you have earned by adding years to your age, length of service, or both. Another option employers have is to subsidize your early retirement benefit or your qualified joint and survivor annuity option. These types of pension sweeteners are key features to look for in your employer’s offer.
Social Security Benefits
While you are not required to begin receiving early Social Security retirement benefits, retiring early means missing additional years of higher earning potential factored into the calculation for Social Security. Additionally, if you choose to receive benefits before your full retirement age, your benefits will be permanently reduced. Cost of living increases will also be lower because they are calculated from a lower initial benefit amount.
Medical Coverage
Though you can receive early Social Security benefits, you are not eligible for Medicare coverage until age 65. If your retirement package does not include post-retirement medical coverage, you may have to look into alternative methods of obtaining health benefits through Consolidated Omnibus Reconciliation Act of 1985 (COBRA) or private health insurance. This may greatly affect your cash flow in an early retirement.
Remaining Active in the Workforce
If you find yourself having to accept an early retirement offer, even though you cannot afford to retire, you may need to find another job to make up the difference between what you receive and what you need. Many early retirement offers contain noncompetition agreements where you are asked not to work for a competitor or solicit customers from the company. In these cases, you may want to consult a lawyer, so you understand how limited your employment options are. Additionally, if you are leaving to accept a severance when you could have remained employed, you may be forfeiting your claim to unemployment in some states. If you choose to enter a new career field, you should be able to work for a new employer and still receive your pension and other retirement plan benefits.
At Henssler Financial, we believe you should Live Ready, even if it were to include a surprise “Golden Handshake.” An early retirement thrusts you into a lifestyle change that you may not have expected to encounter for another 10 to 15 years. While many people find it easy to adjust to a lifestyle that includes vacations and golfing, every individual is different. If you are considering an early retirement offer, talk to one of our experts at 770-429-9166 or at experts@henssler.com. We can help you Live Ready to financially accept a different lifestyle than you originally planned.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
