Sep 12, 2024
When companies are restructuring, they may offer some employees an early retirement package with severance pay and other incentives.
Finishing work early in return for a lump sum of cash may seem like a sweet deal — but there are some money questions you'll need to consider.
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If you choose to retire before you can claim Social Security, a pension or Medicare, you may need to bridge a gap in your income — and severance (even a six-figure package) may not be enough.
Say, for example, you’re 55-years-old and have been offered an early retirement package that comes with severance pay of $100,000. Should you take the lump sum and do what you can to make that money last through your retirement, or should you buy an annuity that pays out the money over time?
Here’s what you need to think about.
Deciding if early retirement is right for you
The first thing you will need to consider is whether you actually want to retire. After all, early retirement isn’t for everyone, especially for those who enjoy their work and the social connection it offers. Retiring early also means you have less time to build your nest egg — and less time for the power of compound interest to work its magic.
At 55, you’re too young to claim Social Security — the earliest you can start is age 62, when you’d have to take a reduced benefit for claiming before your full retirement age (between 66 and 67 for most people).
It’s also worth considering that you may still have your highest-earning years ahead of you, so retiring early could negatively impact both your Social Security benefit and retirement savings.
If you decide to claim Social Security at age 65, the same year you’re eligible to receive Medicare, that means you still have a decade of living costs to budget for. Unless you have a lot of money in savings — the average American does not—you’ll need to find a way to bridge the gap. That’s where an annuity could come in.
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An annuity is a financial product typically issued by an insurance company. In exchange for making a lump sum payment or a series of payments (known as premiums), you receive regular payments over a specified period or for the rest of your life, depending on the type of annuity. An annuity can be structured to provide payments monthly, quarterly, semi-annually or annually.
A lifetime annuity provides payments for the duration of your life, while a fixed-period annuity, also known as a term certain annuity, provides payments for a predetermined number of years, such as 10 years. The payments you receive include both principal and interest, though the specifics can vary based on the annuity’s terms.
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Bridging the gap with an annuity
A lifetime annuity can be used as a retirement income vehicle that addresses the risk of outliving your savings. It’s almost like creating your own pension. On the other hand, a term certain annuity can bridge the gap between early retirement and the age when you can take Social Security, your pension or start withdrawing other retirement savings.
One downside of annuities is that they’re illiquid, so if you need to withdraw funds prior to the end of the term, you’ll typically have to pay a surrender charge. You might also have to pay a penalty of 10%, as well as income tax, to the Internal Revenue Service (IRS). Annuities can be complex, with various fees, charges, and penalties, so you may want to seek out the advice of a trusted advisor before purchasing.
If you choose to accept your company’s early retirement package and you’re worried about getting by until you hit your full retirement age, you could purchase a 10-year term certain annuity. This may not be enough to live on, but you could supplement it with other income or another job to help out.
You could also choose to invest the $100,000 severance elsewhere. For example, you could potentially lower your tax bill by directing the money into a tax-advantaged vehicle like an individual retirement account (IRA), but that means you wouldn’t be able to use the money straight away. You’d also have to compare the benefits of an annuity with other investment options, which could have higher returns but more risk.
Your options will depend on your goals now and in the latter years of retirement. You may want to seek out the advice of a financial advisor who can help to map out a plan that fits your unique needs.
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Vawn Himmelsbach is a veteran journalist who has been covering tech, business, finance and travel for the past three decades. Her work has been featured in publications such as The Globe and Mail, Toronto Star, National Post, Metro News, Canadian Geographic, Zoomer, CAA Magazine, Travelweek, Explore Magazine, Flare and Consumer Reports, to name a few.
