Evaluating Retirement Buyout Offer

Someone recently asked for help evaluating a retirement buyout offer from their employer. They are in their early 60s and have worked at the same place for 40+ years.

Example Early Retirement Buyout Offer

It came in the form of a letter with a couple of attachments. The letter provided an overview of the process and the components of the offer. The first attachment broke down the criteria of who at the company received this offer (by position and department, age requirement, years of service). The second attachment was an example contract that filled in the amounts of the offer.

This particular offer was something like 6 months of pay, a small one-time bonus to cover healthcare costs, and a chance to cash out 30 days of unused sick pay. The decision had to be made in something like 60 days and would be effective within 90 days after signing.

Finding “Gotchas”

I looked for places where rights or earnings would be given up. Some examples to check:

  • Can unused vacation time be cashed out?
  • Can unused sick pay be cashed out?
  • What is the rate for COBRA health insurance coverage?
  • Can you go back to work for the organization as a contractor / temp? When?
  • Can you work for any competitors?
  • What rights do you give up by taking the funds, such as no age discrimination lawsuits?

Estimating Healthcare Gap

The most important piece to this person was healthcare. At the time of this writing, there is a lot of uncertainty around how healthcare will work going forward. This person will be eligible for Medicare when they turn 65 so would need coverage until then. Say a total of 20 months of coverage are needed until they are covered by Medicare. Multiply this by the monthly cost (say $500) to get an estimate of health insurance needed: $10k.

Make sure the COBRA coverage term is that long. Check if premiums can increase for any reason. Check if coverage can be lost for any reason. Check what would happen if you were to have an accidental gap during the transition — do you then have to wait 90 days for anything to be covered again? What about pre-existing conditions? Details, details.

Estimating Lost Retirement Contribution (401k)

This employer offers a 401k. If this person retires 20 months early, they are losing possible retirement contributions to their 401k. Let’s say the employer matches 100% of the first 3% of salary. If salary is 100k, savings rate is 3%, then $3k per year of matching funds is lost. At 20 months, that’s more like $5k of lost contributions.

Estimating Lost Pension Benefits

This organization didn’t offer a pension. If so, the math gets more complicated. For example, I’ve heard of companies who offer 2% of salary for every year of service. Salary for this example is an average of last 5 years of total compensation. Missing out on ~20 months of higher pension payments would require a higher buyout offer, all other things being equal.

Retirement Buyout Taxes

Typically a pension would go into an IRA and the employee would be able to defer taxes until they make withdrawals. Check with your CPA.

However, some “voluntary retirement incentive” or “voluntary early retirement incentive” payments are treated like normal pay. These incentive payments are subject to normal federal tax and FICA. Thus, timing becomes really important to your tax bill.

Example: If you could take half the early retirement bonus in December and the rest in January you would be able to smooth your income and reduce taxes. The details on timing of payments should be in your offer letter.

Estimating Social Security

The free government tools for estimating your Social Security payments are excellent. Make sure you consider the range of different ages as payouts go up the longer you wait to start collecting.

Estimating Part Time Work

Let’s say you want a retirement income of $5k per month and would only have $4k per month after accepting this buyout offer. How do you make up the gap of $1k?

You could work part-time. Let’s say you have 20 hours per week you are willing to work, and need to make $1k per month. You would need $12.50 per hour to make up that gap ($1k / 80 hours). Adjust that amount up if you need to account for taxes.


Hope this helps those out there who are trying to evaluate early retirement offers. There are so many variables they can’t all be covered here, but let me know if you have any comments below.

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