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Getting an early retirement offer can be a double-edged sword. On the one hand, it's an opportunity to kickstart early retirement with a bit of severance pay and, potentially, extended benefits. On the other hand, receiving an early retirement offer can feel like an invitation to leave work before you're financially and emotionally ready.
Employers often extend early retirement offers to encourage employees to exit a company before they would typically retire. If you receive one, it's important to understand the terms of the offer and how it might fit into—and alter—your existing retirement plans. Here are some basics of early retirement to work through as you size up your offer.
How Do Early Retirement Packages Work?
In a retirement buyout, you agree to voluntarily leave your position in exchange for cash and other incentives. Early retirement offers are often made to senior management or longstanding employees who are nearing retirement age as a way to reduce payroll without doing forced layoffs. Typically, you get a window of 60 to 90 days to consider your options.
Early retirement packages vary widely but generally involve a payout, which may include extras like continuing health insurance coverage, life insurance, financial planning or career planning services. An offer may provide enough money and benefits to bridge the gap between your current employment and your planned retirement, but not necessarily. One of the key challenges for recipients is understanding the many financial impacts of accepting early retirement and determining how secure (or insecure) your way forward might be.
What's in an Early Retirement Offer?
When you're evaluating an early retirement package, the first step is understanding what your employer is offering. Here are three common components.
The Payout
Payouts are at the core of any early retirement offer. Your employer may develop a payout formula to apply to multiple employees at your company. They may also create an offer tailored just for you. Your payout may take one of the following forms.
- Lump sum/cash out: Your employer pays you a designated amount of money to terminate your employment. One common formula is to award you one or two weeks' worth of pay for every year of service. If you've worked at your company for 24 years, for example, you might get 48 weeks' pay, or nearly a year's salary.
- Accrued vacation and sick days: Your package may also include compensation for any accrued paid time off.
- Continuing salary: Instead of a cash payout, you may continue receiving your current salary for a set period of time. Receiving your payout over time might help you avoid getting bumped into a higher tax bracket and owing a larger tax bill.
- Bridge payments: Your early retirement package may be designed to help bridge the gap between your current job and your planned retirement. For example, you may be offered payments that last until you are eligible to collect Social Security at 62 years old.
Extended Benefits
Your employer may agree to continue certain employee benefits as part of your retirement package. For example, they may add years of service to allow you to qualify for pension benefits. Employers typically must offer the option of continuing your health care benefits under the Consolidated Omnibus Budget Reconciliation Act (COBRA), but they may also offer to pay for your health coverage for a period of time as part of your buyout.
Additional Services
An early retirement package may include outplacement services, retraining or education to help you transition to a new job or career, if that's your next step. You might also be offered financial planning services to help you integrate early retirement incentives with your existing retirement plans and resources.
How to Assess an Early Retirement Offer
Early retirement incentives open up new possibilities, but they also require you to do some careful thinking. Here are three broad questions to consider as you work through the details of your offer.
What Is It Worth?
Together with your existing resources, is your offer enough to sustain you through retirement—or to your next opportunity? Could it provide seed capital for a new business or supplement your income at a less demanding job?
What Will It Cost?
Accepting early retirement could cost you in the long run if it translates to fewer years of earning income, smaller Social Security checks or out-of-pocket health care costs. Uncertainty is also a type of cost: Your future income and opportunities may be less clear-cut if you leave your job.
What Are the Alternatives?
Is there a secure path forward if you stay with your current employer, or are they likely to eliminate your department or downsize later? Can you find a comparable job elsewhere or pursue a new career path? Can you lower your living costs now to adjust to an early retirement? One way or the other, can this offer work for you?
Other Considerations When Weighing Early Retirement
In addition to understanding the terms of your offer, you'll need to understand its impact on your retirement plans and finances, including the following considerations.
Retirement Savings, Pensions and Income
Retiring early reduces the amount of time you have to save for retirement, while increasing the amount of time you'll spend utilizing your retirement funds. You'll also have less time for investments to grow. As a result, you may have less money to tap in retirement, which means less income.
Early retirement may also affect your eligibility for pension programs at work. If you have a pension plan, be sure to ask what you can expect if you decide to accept early retirement.
Taxes
Using retirement funds from a 401(k) or individual retirement account (IRA) to supplement your income in early retirement could result in early withdrawal penalties. As a general rule, an early withdrawal penalty of 10% applies when you take money out of a traditional IRA before age 59½. You may be able to withdraw money penalty-free from your current employer's 401(k) plan if you're at least 55 when you leave your job. Additionally, withdrawals from a traditional IRA or 401(k) plan are taxed as ordinary income.
Also remember that money you receive as part of an early retirement package is considered income and is taxable in the year you receive it.
Social Security
Social Security retirement benefits begin at age 62, though Social Security considers the full retirement age to be 67 for people born in 1960 or later. Here's the catch: Your monthly benefit at 62 could be more than 33% less than what you'd receive if you waited until full retirement age to start receiving checks.
Also, Social Security averages your income over 35 years to calculate your benefits. If you've worked less than 35 years, retiring early could affect how much you receive. If you're unsure where you stand, visit SSA.gov to set up an account and estimate your benefits.
Health Care
Medicare eligibility begins at age 65. If your employer doesn't offer continued health coverage, you may have to buy your own insurance. Health insurance can be costly, particularly in the years leading up to Medicare eligibility.
Lifestyle
Retirement brings about major changes in spending and lifestyle. Will you miss going to the office and interacting with coworkers? Can you afford to continue living in your home? Will early retirement mean cutting back financially, which could make your dreams of traveling or helping your grandchildren through college more distant?
How to Ensure a Secure Retirement
Whether you're retiring after decades of careful planning or suddenly considering an early retirement after receiving a buyout offer, taking a comprehensive view of your retirement plans is crucial. To help ensure you can retire comfortably without running out of money, take a close look at your retirement finances, including income, health care costs, housing and lifestyle.
- Get help. If you can, work with a financial planner to fully understand how your early retirement payout fits into a larger retirement plan. If retirement isn't in the cards right now, what do you need to do to keep yourself on track to retire as originally planned?
- Ask for what you need. Although your options may be limited, you can negotiate some terms of an early retirement offer. For example, if you're covered by your spouse's health care plan, you might see if you can trade health care coverage for additional cash.
- Know your options. You don't have to accept an early retirement offer if the terms don't work for you. Hang onto your job, but be aware that early retirement offers sometimes foreshadow layoffs to come. Or, use your early retirement offer as a sign that it's time to start developing new options, whether or not you accept your buyout now.
The Bottom Line
Accepting, rejecting or negotiating an early retirement package is highly individual. Every early retirement offer is different, and so is every situation.
If you're being offered an early retirement package, think through the long- and short-term ramifications. Taking an incentive to retire early and pursue a new chapter of life can be a positive, even transformational, opportunity. But, it almost certainly requires a re-assessment and recalibration of your current retirement plans, and a new strategy for how you would like to live in the years ahead.