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What should I address upon acceptance of an early retirement incentive package?

August 24, 2021
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If you have accepted an early retirement incentive* buyout from your University or College, here are 7 questions to answer before your last day of work. Fortunately, many separation programs run through the end of the semester or school year so there may still be some time to determine whether these opportunities are right for your situation. Address the following questions to insure the most successful transition to retirement.

How will healthcare coverage change and are there things to do ahead of time to prepare?

Make sure you understand how your healthcare will be covered once you leave work. If you are eligible you should sign up for Medicare. Next, consider what coverage you need to supplement the Medicare coverage and whether your employer provides that through any retiree health plan. You will want to compare costs of a retiree plan with coverage you can obtain on your own. If you are not eligible for Medicare, then investigate COBRA benefits to determine your eligibility and coverage options.  

Check with HR to see if there are any other special circumstances to consider.

What is the timing, payment schedule and taxation of the incentive payment?

Incentive payments can be made in lump sums or installments for a fixed period. It is important to understand how your incentive payment will be paid, how it will be taxed and whether you have any flexibility in how you receive the payments.  Often incentive payments are taxed at a fixed rate which may be higher than your regular withholding. The tax withheld may reduce the net income you receive in your payment but not your actual tax rate or how much tax you owe. It is important to factor in whether there will be sick pay and vacation pay that is paid out as well and this will often be fully taxable too.

How much do I need for income on a monthly basis? 

If you do not have time to do a comprehensive budget prior to your last day, consider this alternative. Look at all deposits you have received over a specific timeframe (such as three to six months) and see how much your bank balance has changed. This analysis will help tell you whether you are spending all your take-home pay. Make sure to check if there are any direct deposit payments in your paycheck (e.g., for car loans) and add those back to your spending total.

See this simple budgeting example to determine your monthly cash flow needs. 

Going through this exercise is important because it can help identify if you need to look at other income sources or whether you need to address other strategies such as how to tax defer your payments. 

Where should I take income if my incentive payment does not meet my income needs?

You may need other sources of income to meet your spending needs. Your income likely will come from some combination of three sources: guaranteed income sources, ongoing cash flows from non-guaranteed sources and withdrawals from your investment and cash accounts. 

Social Security and pension options will provide guaranteed income sources, but it is important to investigate tax consequences as well as any benefits from delaying your start date.

identify any cash flows that you haven't been using such as real estate income, book royalties, investment income etc. which are likely to be taxable income and therefore a good source to start using for spending needs.  

Next you will coordinate withdrawals from your retirement and taxable investments and cash. It is extremely important to consider taxes and investment allocations as you start to draw from these accounts. 

What if the incentive payment causes a surplus?

If your payout causes surplus income and you already have plenty of cash reserves then investigate options to add the surplus to your existing retirement plan. It is important to consider how to allocate the lump sum into your existing portfolio. Depending on when you plan to withdraw the allocation you may invest these funds more conservatively than your current investment mix.

As an alternative, you can look at gifting strategies for family members or charitable organizations. In either case there are unique options available depending on your specific goals. For family members the annual gift tax exclusionprovides many opportunities.  

Are there any tax strategies that should be considered?

The payments you receive may cause more taxable income than you need especially if the payment is made in a lump sum. If vacation and sick pay are also included you may end up paying more in taxes than expected and therefore it is important to factor any tax strategies that may not be available after you are retired. 

One option is to reduce your income by tax deferring more. If you are unable to defer from the incentive payment itself, you may be able to defer more during the period prior to your retirement date. It may also be possible to defer into a health savings account as well. You will want to check with human resources to see what is available.  

If reducing taxable income is not an issue but you still want to save as much as possible, consider making large Roth contributions into your retirement accounts.

What other things should I be thinking about prior to my last day of work?

Check to see if you can still access gyms, on-campus parking, and research labs. Make sure you understand how long you will have access to emails and contact information on any institutional network.  Investigate whether you will maintain your existing office space or do you need to consider a game plan to go through all your past research, documents, and books. Consider any payroll deductions such as car loans, education savings etc. that need to be switched to a new bank account.

Are there experts who can provide guidance through this process?

There are many details that go into the above strategies and other points to consider.  You will want to coordinate the information from experts such as your human resource contacts and tax advisor.  If you need help making the most of your early retirement incentive payment, talking to a knowledgeable and experienced financial advisor is an excellent first step. 

*These plans can also be referred to as VRIP (voluntary retirement incentive plan), ERIP (employee retirement incentive plan, VSIP (voluntary separation incentive plan) or VERIP (voluntary early retirement incentive plan) among others!  

Financial Planning Services offered through The Foundry Financial Group, Inc., a Registered Investment Advisor. Investment Advisory Services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and The Foundry are not affiliated.





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