How to Make an Early Retirement Package Work for You
An early retirement package can be a great opportunity or a disaster. It all depends on how well you plan. Below are 8 things you need to know before you accept an early retirement offer.
Choose Pension Options Independently of Your Early Retirement Package
Many pensions give you a choice as to when to start your benefits. If you have savings it may be to your benefit to use your savings to cover living expenses and to delay the start of your pension. It will depend on your pension options. We have seen cases where there is no benefit to delaying the start of a pension, so you can't rely on a rule of thumb. Instead, you will calculate what you will receive over your lifetime with one option versus another and compare choices.
If your pension offers you the choice of lump sum or annuity, be sure to do a thorough analysis before you decide. In the majority of cases I look at, the annuity turns out to be the best choice but not always. This is a great decision to talk over with a financial planner.
See If Using IRA Money First Might Be Best
The standard rule of thumb is that you don't touch your IRA or retirement money until you either reach age 72 (70 ½ if you reach 70 ½ before January 1, 2020) when you have required minimum distributions. This rule of thumb is wrong. If you have no more earned income and are thus in a low tax bracket, you may be able to take IRA withdrawals and pay little-to-no tax.
Deciding how to coordinate when you take IRA withdrawals with your other sources of income in a tax efficient way can mean more after-tax spendable income will be available for you. Managing withdrawals in a tax efficient way is important and an early retirement package offer may present opportunities to take advantage of being in a low tax bracket.
Evaluate Healthcare Options
Individual healthcare coverage is expensive. If ongoing healthcare coverage is not part of the early retirement package being offered, make sure you know how you are going to afford coverage when whatever is being offered comes to an end. When you add in the healthcare benefits that some low paying jobs offer, it is the equivalent of being paid double.
Sometimes when you price in the value of healthcare coverage you'll decide it's worth sticking with a low paying job, or a job you don't love. Other times it won't be worth it, but make sure you're ready for the expense. You can go to healthcare.gov or shop the major insurance providers for quotes. That will at least give you an idea before making a decision.
Layout a Timeline
The best way to forecast how an early retirement package or any proposed retirement plan will work is to lay out a retirement income timeline. It's a spreadsheet that tracks future income sources and expenses year by year, along with your age. You can use this timeline to visually see when you might turn on certain sources of income like Social Security or your pension.
Learn the 401k Retirement Age Rules
If you've been offered an early retirement package and you are between the ages of 55 and 59 1/2, your 401k plan offers you the ability to take withdrawals and pay no early withdrawal penalty tax, even though you are not yet age 59 ½.
You have to leave the money in your plan to use this option. Make sure you understand the 401k retirement age rules before you start moving money around. In general, I think most people are best-off consolidating retirement accounts, but if you are leaving employment between the ages of 55 and 59 ½, it might not be time to consolidate yet.
Explore New Ways to Make Money
Once you've accepted an early retirement package think about using your time to explore new ways to make money. Evaluate your strengths to see how they may be packaged up in a new way where you could pursue work you really enjoy. You might consider starting a consulting business, doing some research on small business start-ups, or finding ways to turn hobbies into earning extra money.
The longer you can leave your retirements funds invested, the more time they have to grow. Since most people are behind on retirement savings, it pays to earn money in other ways before tapping retirement funds. Remember, work from home opportunities are becoming increasingly common.
Stress Test Your Plans and Have a Back-Up Plan
The most important thing you can do is stress test your plan. What if investment returns are lower than you think they will be? What if an adult child gets in trouble and you need to help them out financially? What if your early retirement package decision is dependent on your spouse continuing to work and they have a health event that forces them out of the workforce early? Make sure you are comfortable with the answers to the "what if" questions and think about your backup plan. Would downsizing be an option? What changes could you make if things don't go just right?
Get Smart About Social Security
Many people take an early retirement package and then also claim Social Security early because they don't yet want to tap into their own savings. This can be a big mistake. Contrary to what you might think, in a low-interest rate environment your money is likely to last longer if you tap into your own savings first and delay the start date of your Social Security benefits.
Married couples, in particular, can use the Social Security rules to get more combined benefits between the two of them if they are willing to be open-minded, learn how the rules work and develop a coordinated plan. If you take an early retirement package don't mistakenly assume that means you have to take Social Security early. You may be inadvertently hurting your financial security by doing this.