Make the Most of a Buyout Offer
Handled wisely, your buyout could help you build a bridge to retirement without jeopardizing your financial security.
Receiving a buyout offer is certainly preferable to having a security guard escort you to the parking lot, but it can still be disconcerting—especially now. Many employees of airlines and other businesses decimated by the coronavirus pandemic may feel that they have no choice but to accept the offer, because the next notice from human resources will probably have layoffs in the subject line.
Before you make any decisions, conduct a thorough analysis of your net worth—everything you own, everything you owe and all of your sources of income. Then do an inventory of how much you spend, says Thomas McCarthy, a certified financial planner in Marysville, Ohio. And don’t just jot down items that pop into your head. “We spend money on a lot of things we just don’t track,” McCarthy says. When people use bank expense-tracking apps or other tools to monitor all of their spending, “it’s usually an eye-opener,” he says.
Whether you have a choice about taking a buyout or not, consider what will happen to your health insurance. Still working but expecting a buyout offer? Schedule elective surgery, dental appointments and other procedures covered by your employer’s health insurance to take advantage of that coverage while you can. Although some employers continue health insurance as part of the buyout package, such offers are increasingly rare.
Lump sum versus traditional pension
If your employer has a pension plan, one of the most difficult decisions you may face—in large part because it’s usually irrevocable—is whether to accept your retirement benefits as a lump sum or as a traditional pension with monthly payouts. Your choice should be based on a number of personal factors.
Marital status. If you’re married and choose to take a pension with a joint-and-survivor payout, payments will continue for as long as one spouse is alive. This is a valuable benefit you shouldn’t overlook, financial planners say. Even if you don’t expect to live well into your nineties, your spouse might. Taking a traditional pension will guarantee that he or she won’t run out of money.
Your employer’s financial health. Many workers opt for a lump sum because they’re afraid their employer will go down the tubes and take their pension with it. But you do have some protections. The Pension Benefit Guaranty Corp. guarantees your pension in the event your employer files for bankruptcy, but only up to a specific amount that’s adjusted every year. In 2020, the maximum guarantee for a 62-year-old with a single-life annuity is $55,104 a year; it’s $49,596 for a joint-and-survivor annuity.
Before making a decision, ask your employer to provide you with a report showing the funding level of its pension, McCarthy says. The company is legally required to provide that information. If the report shows that the company’s pension obligations are funded close to 100%, you should feel comfortable choosing that option if it’s right for you, he says.
Other sources of income. Not everyone needs a guaranteed stream of income. Barbara Ristow, a CFP with Buckingham Strategic Wealth, in Fairfax, Va., says she recently advised a client whose wife was several years younger, still working and eligible for her own pension. Because the couple could count on her income, they decided to take the lump sum and invest it, allowing the money to continue to grow until they need it.
Your tolerance for risk. If you roll your lump sum into an IRA or your former employer’s 401(k), you can defer taxes until you start taking withdrawals (see below). Once you’ve rolled over the funds, you can invest the money and possibly earn higher returns than you’d get from a pension. Plus, you can leave any money you don’t spend to your heirs—which isn’t an option with a traditional pension.
With the pension, the investment risk “is borne by the employer,” McCarthy says. However, taking the monthly payments now, when interest rates are super-low, will mean lower payouts for the rest of your life. At the same time, investing your lump sum to provide reliable, safe income is challenging because low rates have kneecapped returns from bonds and other low-risk investments. Over the long term, stocks have provided higher returns, but they also expose you to more risk of loss in a downturn.
One way to measure the value of a pension payout is to see how much money you would have to invest in an immediate annuity to get the same monthly payout your employer is offering. You can go to immediateannuities.com to find out. Because payouts on immediate annuities are usually tied to rates for 10-year Treasuries, which are at a record low, the payout your employer is offering is probably going to be larger than one from an annuity you can purchase on your own, says Dennis Nolte, a CFP with Seacoast Investment Services, in Winter Park, Fla.
Tap Social Security early?
You can file for Social Security benefits as early as age 62, and if you’re forced into early retirement, you may be tempted to claim that guaranteed paycheck as soon as possible. But if you don’t need the money to live on, there are compelling reasons to wait for a few years to file your claim.
If you begin benefits at age 62, you’ll receive up to 30% less in your checks than if you wait until your full retirement age, which is 66 for those born between 1943 and 1954 and gradually rises to 67 for those born in 1960 or later. For each year you postpone taking benefits past full retirement age up to 70, you get an 8% boost in delayed-retirement credits.
Give serious consideration to delaying benefits if you opt for a lump sum instead of a traditional pension, says Mark Beaver, a CFP with Keeler and Nadler Family Wealth, in Dublin, Ohio. There’s no guarantee your lump sum will last as long as you do, but by delaying Social Security, you’ll receive a larger amount of secured income in your later years, which will reduce the risk you’ll run out of money. Plus, the 8% delayed-retirement credits, along with annual cost of living adjustments, will give you a better return than you could get anywhere else without taking a lot of risk.
You should also think twice about claiming benefits at 62 if there’s a chance you might return to work. Otherwise, you could end up losing some of your benefits to the earnings test, at least temporarily. If you earn more than $18,240 from employment in 2020, your benefits will be reduced by $1 for every $2 you earn above that threshold. In the year you reach full retirement age, the exemption is higher—in 2020, it’s $48,600—and Social Security withholds $1 for every $3 you earn, but only in the months prior to the month of your birthday. Once you reach full retirement age, Social Security boosts your monthly check to make up for the benefits you previously lost to the earnings test—and you can earn as much as you want without worrying about the earnings test.
The health care problem
Without question, the most vexing issue facing early retirees is how to pay for health care until they're eligible for Medicare. If you’re married and your spouse is still working, you should endeavor to get on your partner’s plan. That’s the most affordable option because your spouse’s employer is likely paying a portion of the premiums.
If that’s not available, your other options become increasingly more expensive. You can stay on your own employer’s health insurance plan for up to 18 months under the federal law known as COBRA, but in most cases you’ll pay both the employee and employer share of the premium, plus a 2% administrative surcharge. Total average annual premiums (including employer and employee contributions) for employer-sponsored health plans surpassed $20,000 for family coverage and $7,000 for individual coverage last year, according to the Kaiser Family Foundation.
Your employer’s human resources department can tell you what your premiums will be under COBRA; don’t forget to factor in deductibles and other out-of-pocket costs. COBRA is costly, but it will allow you to stay in the same provider network you had while you were working. With that in mind, buyout recipients who are close to age 65 may decide its worth paying the premiums until Medicare kicks in.
Your other option is to find a policy through your state health insurance marketplace (search for your own state’s option at HealthCare.gov). These policies can be pricey, particularly for older people, but because the policies comply with the Affordable Care Act, the insurer can’t turn you down because of preexisting conditions.
If your income is between 100% and 400% of the federal poverty level, you are eligible for a tax credit that lowers the plan premium. For 2020 plans, the upper income limit to qualify for a subsidy is $49,960 for an individual, $67,640 for a family of two or $103,000 for a family of four.
Once you’re no longer working, you may be able to keep your income low enough to qualify for the subsidy, says Jeff Farrar, a CFP with Procyon Partners, in Wilton, Conn. You can, for example, limit how much money you withdraw from tax-deferred IRAs or 401(k)s. Selling losing stocks or minimizing capital gains can help lower your income, too. Because a portion of your Social Security benefits may be taxable, depending on your other income, delaying those benefits could also help you qualify for a subsidy.
If you’re not eligible for a subsidy, compare the cost of buying a policy from your state insurance exchange with the cost of COBRA. If you expect your income to drop next year—and there’s a good chance that it will, because you’ll no longer be receiving a salary—consider paying for COBRA for the rest of the year and signing up for coverage on your state health care exchange during open enrollment, which starts November 1, says Vinicius Hiratuka, a CFP with Elevated Retirement Financial Services, in Madison, Miss.
The tax credit will be based on your estimated annual income for the year you’re seeking coverage—not this year’s income. You’ll have to estimate how much income you’ll receive next year, and when you file your tax return for the year you had an insurance policy, you’ll have to repay any extra amount you received in advance tax credits if you underestimated your income.
Stay out of the penalty box
When you accept a buyout offer and leave your job, you may be tempted to roll the balance from your former employer’s 401(k) into an IRA. And in many instances that makes sense—you can invest your money anywhere you want, and you may have more flexibility when it comes time to take money out (some 401(k) plans limit the number of withdrawals you can take). But if you’re younger than 59½ and think there’s any chance you’ll need money from your savings to pay for living expenses, you should leave your money in your 401(k) or other employer-provided plan.
Here’s why: When you take a withdrawal from a traditional IRA before age 59½, you’ll usually pay a 10% early-withdrawal penalty. But if you leave your job at age 55 or older, you can take withdrawals from your former employer’s 401(k) plan penalty-free. You’ll still owe taxes on the money, but you’ll avoid the 10% haircut.
You can use this strategy to avoid early-withdrawal penalties on a lump-sum buyout, too, says Tom McCarthy, a certified financial planner in Marysville, Ohio. Instead of rolling the buyout into an IRA, ask your employer if you can roll that money into your company’s 401(k) plan. Once the money is in your plan, you can take penalty-free withdrawals as early as age 55.
Workers who are older than 59½ don’t have to worry about the 10% early-withdrawal penalty, but you still want to avoid a tax hit on your lump-sum payment. Make sure you instruct your employer to roll the money directly into an IRA so you can defer taxes until you start taking withdrawals.