Posted by Cindy Wilson.
An earlier-than-expected escape from the daily grind, coupled with an attractive lump-sum severance, can be hard to resist. But before accepting that early buyout, it’s vital that you carefully weigh the pros and cons.
I’ve noticed that near-retirees have a determined look about them, like they are rushing full-speed ahead towards that finish line. Suddenly, they are counting the days until they can log out of their work computer for the very last time—and that final mile seems the longest. I’ve met plenty of burnt-out employees in this situation who would give anything to get to that finish line sooner. In other words, an early buyout from the rat race.
If you ever have the luxury of choosing between working to full retirement age and taking a healthy, early retirement, make sure to get your offer in writing, before considering these important factors:
- How much is being offered? It is typical for employers to calculate a severance package based on length of service, for example two weeks’ pay multiplied by however many years you’ve worked for that employer. Severance payments, like any amount ending in a series of zeroes, can be dazzling by their very size. But you’ll likely be retired for a long time, and will, therefore, need to view the severance total in terms of the number of years you expect to live in retirement—likely several decades.
- Will the payments be spread out? I highly recommend you schedule a meeting with an accountant to look at the taxability of payments. Having your severance spread out over several years can help minimize the taxes you end up paying.
- How will an early exit from the workforce affect your retirement income? Retiring early means stretching your set amount of savings over more years—and fewer years in which to save. The years immediately before retirement are when a lot of workers save the most and take advantage of catch-up contributions. Set up a meeting with a financial professional from the company in which you have most of your assets invested, to get projections on lifetime payments and to determine how an early retirement will affect your estimated retirement income—factoring in the amount you’ll receive in a severance package as compared to your lost earnings. Bring your quarterly statements in a binder and list your current expenses next to the expenses you expect to have in retirement. These expenses may be affected by big life events, such as downsizing. I recommend including your accountant in this meeting, even as part of a conference call.
- Does it include a benefits bridge? If you’d been planning on delaying your Social Security benefits until age 70 in order to get the highest possible monthly amount, you may be faced with the prospect of claiming earlier than expected. Some retirement packages offer a benefits “bridge” in addition to severance to cover the period between your early retirement and age 62, when most people first become eligible to claim Social Security.
- Are you likely to find another job in your field? If you’re simply not ready for rounds of golf and afternoon cocktails, you may decide to look for another job in your industry or even embark on a whole new career. Talk to a recruiter about your chances of finding work. This may be a good opportunity for a phased retirement, a job with fewer hours or responsibilities. If you find a second career and only need to withdraw, say, $10,000 from your nest egg one year, and $50,000 the next, you need your assets to stay fairly liquid; think carefully before irrevocably annuitizing your retirement money; a steady stream of retirement income may not be right for you.
- Will you need to tap into your retirement accounts early? Remember, if you retire before turning 59½, you will most likely face a 10% early withdrawal penalty for distributions from a traditional IRA. Most employer-sponsored retirement plans allow for penalty-free withdrawals if retiring at age 55 or later. If retiring early means you are likely to pay a penalty, it may not be the best choice for you.
- Will you get to keep your medical and dental benefits? By accepting an early retirement package, confirm that you will be allowed to keep your medical coverage until you become eligible for Medicare at age 65.
- Are you emotionally ready? However financially ready you may be, an early retirement can have profound psychological effects, especially if it comes unexpectedly and there’s no time for real preparation. I have spoken with people who eagerly retired at 65 or even 70, then struggled to regain the sense of purpose and fulfillment that is a byproduct of working for a living.
Although your first impulse may be to grab at whatever’s offered, an early retirement package needs to be considered very carefully—in light of your current finances, your future income sources and also the psychological impact.