Last month, I received an email titled “Early Retirement” from a client who has been working for the same Fortune 500 company for over 40 years. He was planning to retire in June but had not put in his notice. They offered him 14 months of pay plus health benefits for that period, which carried him to the day he became eligible for Medicare. While it may seem like a big win, sadly, this is an anomaly in early retirement packages. They often come too early and with too few zeros to justify an actual retirement. Because of this, it is important to know exactly what to know when considering early retirement.
What To Know When Considering Early Retirement
While the unemployment numbers for April 2020 have yet to be released, we are likely to jump from 3.6% in January to somewhere close to 20% in April. To put that in context, unemployment peaked just below 10% during the Great Recession in 2009 and has not been over 20% since the Great Depression. This means it is likely that more companies whose sales have been slashed to zero will begin considering more early buyouts as they scramble to find ways to cut expenses. If you are offered an early exit and intend on taking it, below are five necessary steps to take before you accept the early retirement buyout.
1. Determine Whether You Are Retiring Or Are A Free Agent
The last time we saw significant rounds of buyouts was between 2007 and 2009. To this day, I still encounter individuals who never found a way back to their career after taking a payout during that time. This is a good time to objectively evaluate how employable you are if you are out of work for anywhere between 1 and 2 years.
You will need to figure out if you are in a “work-optional” position from a financial perspective. A certified financial planner can help you run the numbers to see if you are financially independent, but if you are looking for a quick, simple way to assess your current position, consider this example:
- Monthly Expenses (including taxes): $10,000
- Monthly Income Streams (pension, Social Security, etc.): $4,000
- Monthly Gap: $6,000
- Annual Gap: $72,000
- Necessary Nest-Egg to fund gap: $72,000/.04 = $1.8 million
This method utilizes the “4% Rule,” which is accurate but by no means foolproof. However, if you are significantly below the target, you will need to cut your expenses or consider yourself a free agent in order for work to be optional.
2. Understand Your Monthly Income And Expenses
Not having a grasp of your monthly expenses is either a luxury for those who make more than they spend or a critical mistake for those with consumer debt. When you decide that you are ready for retirement and transition from worker to retiree, it is no longer an option. You will notice that the primary driver and the first number in the above example of figuring out if you have enough money to retire is your monthly expenses.
A typical response I receive when initiating the expense conversation is, “I pay my property taxes in July and, of course, I always spend more money during the holidays. Last year we renovated the bathrooms. That does not count, does it?” Determining your monthly expenses may seem daunting for most, but it does not have to be.
The simplest way I have found to come up with an accurate monthly number is by dividing all debits from all bank accounts over a two-year period by 24. If you have online banking solutions, this should take no longer than five minutes. And yes, the bathroom renovation does count for this exercise. There will never be a point in your life when you do not have larger expenditures — therefore, it is important that you build them into your budget. For those who would rather use technology to handle this task, online resources Personal Capital and YNAB (You Need a Budget) will work.
If you are under 65 and do not have health insurance from a source other than your employer, think twice before considering yourself a retiree. It may not seem like it, as you are shelling out a few hundred bucks per month for health premiums, but it is likely that your employer is paying a significant chunk of your premium. When you walk away before you are 65, you will have to find a plan on your own, and if you have not already shopped around, you are going to be shocked by the premium, deductible, or both. While COBRA is thought of as being “expensive,” it is likely to be your best option in this case. This expense will not come up in your expense apps as it is a payroll deduction, so you must figure out what is realistic and add it to your monthly budget.
3. Create A Plan To Receive More Income
When you signed your last offer letter or employment agreement, the words “we will be offering you a gross annual salary of $100,000” was your income plan. The money gets deposited a couple of times per month and you live off of your wages that were defined in the agreement.. When you decide to retire and end the agreement, you will no longer have that income plan. I often speak to people with advisers, transitioning into retirement, who have no idea where they will pull their money from when entering retirement. Perhaps this is why, according to the Social Security Administration, more than 50% of people take their benefits before full retirement age.
When Social Security was enacted in 1935, the full retirement age was 65. Eighty-five years later, people still think of 65 as a “normal retirement age.” Extending that theme, it is common for people to “turn on” their Social Security whenever they retire. However, so long as you have a nest egg that you will draw down in retirement, you need to decouple those decisions. Between your full retirement age and 70, your Social Security income will increase by a guaranteed 8% per year. When considering your income plan, you want your fastest growing investment accounts to be the last you withdraw from. These are usually Social Security and Roth IRAs.
There is a very popular direct-to-consumer men’s shoe company called Taft. Two times per year, their shoes go on sale. Unlike normal retailers, who discount last season’s items that did not sell, this sale is on everything. Essentially, it means you could buy the same product on Tuesday that you did on Monday but for 20% less. On Wednesday, they are back to full price. The same is true when you pull money from your investments. If your tax rate is lower because you are not working, you will pay less to pull the same amount out of a 401(k). If your tax rate is higher, you may be better off pulling from a Roth IRA. Drawing from the right account at the right time can often lead to six-figure differences in taxes over the length of your retirement.
4. Consolidate Your Investment Accounts
Finding $20 in the pocket of a pair of shorts you just pulled out of the closet is exciting. Finding $5,000 in a retirement account that you forgot existed should be embarrassing. Because of this, I keep all of my investments, outside of my 401(k), and my bank accounts at one institution. It is not because I believe that one institution is the best at everything; it is because I want to be able to log into one place to see everything. If my investments change in one account, I can see the impact on my overall asset allocation. This is even more important as you start to draw down your investments.
In 2016, I met with an 88-year-old who had 18 different bank accounts. That is not a typo. I have heard more extreme examples from estate attorneys. If this is you, you are creating a nightmare for your heirs. If you are walking across the street and happen to get hit by an ice cream truck, you want a checkbook to fly out of your pocket, not a handful of changes that your beneficiaries will have to spend months or perhaps years looking for.
5. Get Smarter With Your Investments
You have just peaked Everest — you determined you have the resources and desire to accept the buyout offer from your employer — now, it is time to head down the mountain. The muscles and strategies you used to get to the top are not the same ones you will use to safely navigate the descent. Essentially, what got you to retirement will not get you through it. I always tell people that volume gets you to the point where you can retire. Volume of savings. Volume of time. Volume of return. When you are spending your money, it takes consistency, discipline and planning.
Consistency is critical when it comes to your investments. You want them to resemble more of an escalator than a roller coaster. While this is easier said than done, properly diversifying your portfolio with stocks and high-quality fixed income is a good first step. Our firm works exclusively with this by utilizing a dynamic strategy that systematically increases or decreases stock exposure based on market performance. This is formula-based and would be difficult to replicate from your living room.
Discipline is often a function of investing within your risk tolerance. If you are only comfortable seeing your portfolio go down 10% and you saw it sink by three times that in March, you were at risk of making a bad decision before it rebounded. In retirement, you have an allowance of only a few really bad decisions before you are back on LinkedIn looking for opportunities. As a result, you need to ensure you are investing smart and investing the right way.
Speak With A Certified Financial Planner
Your retirement plan puts all of your finances together. It should say how much you can spend and where it will come from while accounting for tax efficiency and inflation. Once again, easier said than done, but there is software that will do this job for you. Additionally, there are plenty of certified retirement planners who can make your life easier and ensure you will never have to worry about navigating retirement and financial planning again.
When I was 19, my pediatrician finally forced me out of his practice. In between appointments measuring the head size of infants, he had a 6-foot, 180-pound college student sitting on the fire truck table. I no longer fit in his practice or his expertise. As you transition into retirement, it is possible that you have become that patient for your current financial adviser. Consider working with someone who specializes in retirement financial planning.
Learn more about the author, Evan Beach, by visiting his team member bio page.
This is for informational purposes only and should not be construed as financial advice specific to your specific situation.