In today's corporate environment, where cost cutting, restructuring and downsizing are the norm, employers are offering their employees early retirement packages. Your employer may refer to the offer as a “golden handshake” or a “golden parachute”. 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.
Evaluating an early retirement offer
The decision of whether to accept an early retirement offer is not an easy one to make. There may be multiple pieces of the offer—continuing pay for a certain length of time, health insurance considerations, lump sum payment, non-compete provisions, etc. Your company's personnel department may provide either individual or group counseling to guide you during this important decision-making process. Find out what amount you can expect to receive each year after you retire. Then, consider whether you will look for other employment, as well as figure out the difference between what you would collect if you retired early and the amount you would earn if you continued working.
You should discuss your personal situation with an attorney and/or financial professional. Although a company-paid consultant may provide valuable information, they may not necessarily be acting in your best interest.
Tax/retirement plan implications
If you accept an early retirement offer, you should be aware of any possible tax implications. If you receive a lump sum for pay, how does that impact your current tax situation? If you plan to fully retire, defined benefit plans often contain provisions that reduce your monthly benefit when you begin distributions before a certain age. As a result, early retirement can result in lower future monthly retirement benefits.
Taxable distributions from employer-sponsored retirement plans—such as 401(k)s—and Individual Retirement Accounts (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. One important exception to the 10% premature distribution tax is for substantially equal periodic payments—sometimes called SEPPs. There are strict IRS guidelines, and this option should be discussed with a financial professional before electing it.
Provided that you're over age 59½ or meet one of the exceptions, you can take penalty-free withdrawals from your account/plan. However, you may still have to pay income tax on all or part of the withdrawal. Distributions from employer-sponsored plans are usually taxable, since contributions to most of these plans are made on a pre-tax basis (although qualified distributions from Roth 401(k)s and Roth 403(b)s are free from federal income taxes). IRA distributions may or may not be taxable, depending on whether the contributions you made to the account were tax deductible. Roth IRAs are subject to special rules of their own.
Important considerations
After careful consideration, you may find that early retirement is the way to go. However, before you jump right into retirement, you'll want to have a full picture of your financial situation, including the following considerations.
Less time to save for retirement
If you accept an offer to retire early, say at around age 55, you could be giving up 10 years or more of saving for retirement. Less time to save means you may have fewer savings available during retirement.
Retirement savings will have to last for a longer period of time
A lower retirement age, coupled with generally increasing life expectancies, can result in your retirement years making up one-third of your total life span. In other words, you could spend as many years in retirement as you did in the workforce. Your retirement savings will have to last for a longer period of time than if you had retired at the normal retirement age. In addition, you should consider the effect of inflation, which could eat away at the purchasing power of your retirement savings.
Your pension may be smaller
If you participate in a traditional defined benefit plan, also known as a pension plan, accepting early retirement could result in a smaller pension. You should determine whether it is more valuable to have a smaller benefit over a longer period of time rather than a larger benefit over a shorter period of time.
Medicare
Even though you can receive early Social Security retirement benefits at age 62, you are not eligible for Medicare benefits until age 65. If your early retirement package does not include post-retirement medical coverage, you may have to look into alternative methods of obtaining health benefits, such as a combination of COBRA (Consolidated Omnibus Reconciliation Act of 1985) or private health insurance, until you are eligible to begin receiving Medicare benefits.
Social Security
If you accept an early retirement offer, you might consider applying for early Social Security retirement benefits. The Social Security Administration allows any individual who is eligible to receive Social Security benefits at full retirement age the option of receiving benefits beginning at age 62. However, if you decide to receive Social Security benefits before full retirement age, the benefits you receive will be reduced.
If you accept an early retirement offer from your employer, you are not required to begin receiving early Social Security retirement benefits before full retirement age.
Planning for the future
Whether you have the financial resources to retire early depends on how much you have in retirement income and how much you plan to spend, so careful planning is needed.
Busey Wealth Management’s team of advisor can help you create a roadmap for the future. To learn more about our holistic services or find an advisor near you, visit busey.com/wealth-management.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.