In this article:
Employers sometimes extend early retirement offers to encourage employees to exit the company before they are planning to retire. If you receive one, it's important to understand the terms of the offer and how it might fit into—and alter—your existing retirement plans.
Whether you accept an early retirement package may depend on what's included in the offer and how it will impact your retirement income, taxes, lifestyle and more. Here are some basics to work through as you size up your offer.
How Do Early Retirement Packages Work?
In a retirement buyout, you agree to voluntarily leave your position in exchange for cash and other incentives. Early retirement offers are often made to senior management or longstanding employees who are nearing retirement age as a way to reduce payroll without doing forced layoffs. Typically, you get a window of 60 to 90 days to consider your options.
Early retirement packages vary widely but generally include a payout, along with extras like continuing health insurance coverage, life insurance, financial planning or career planning services. An offer may provide enough money and benefits to bridge the gap between your current employment and your planned retirement, but not necessarily. One of the key challenges for recipients is understanding the many financial impacts of accepting early retirement and determining how secure (or insecure) your way forward might be.
What's in an Early Retirement Offer?
The first step is to understand what your employer is offering. Here are three common components you may find in an early retirement offer:
The Payout
A payout entices you to accept your employer's early retirement offer. Your employer may develop a payout formula that applies to multiple employees at your company. They may also create an offer tailored just for you. Your payout may include one or more of the following elements:
- Lump sum or cash out: Your employer may offer you a designated amount of money to terminate your employment. One common formula is to award one or two weeks' worth of pay for every year of service. If you've worked at your company for 24 years, for example, you might get 48 weeks' pay, or nearly a year's salary.
- Accrued vacation and sick days: Your package may include compensation for any paid time off you have accrued.
- Continuing salary: Instead of offering a lump-sum payout, your employer may offer to continue paying your current salary for a set period of time. Getting your payout over time might help you avoid being bumped into a higher tax bracket, which could result in a bigger tax bill.
- Bridge payments: Your payout may be designed to help bridge the gap between your current job and your planned retirement. For example, you may be offered payments that last until you are eligible to collect Social Security at 62 years old.
Extended Benefits
Your employer may offer to continue certain employee benefits as part of your retirement package. Employers generally have to offer the option of continuing your health care benefits under the Consolidated Omnibus Budget Reconciliation Act (COBRA). As part of your buyout, they may offer to pay for your continuing benefits for a period of time. Your employer may offer other types of benefits as well, such as adding years of service to allow you to qualify for pension benefits.
Additional Services
Your early retirement package may include outplacement services, retraining or education to help you transition to a new job or career, if that's your next step. You might also be offered financial planning to help you better understand how your early retirement incentives plus existing retirement plans and resources might support you going forward.
Why Do Companies Offer Early Retirement Packages?
Companies offer early retirement to senior employees as a way to cut payroll costs or restructure their workforces. Early retirement packages are often used as an alternative to involuntary layoffs.
Employers can replace highly paid employees who retire with lower-salaried workers or eliminate positions that are no longer needed following a merger, the introduction of automation or reorganization.
Although early retirement packages may cost more than layoffs, they're seen as more humane and less damaging to employee morale. In an ideal world, an early retirement package is your ticket to an early, graceful exit from the workforce, with no hard feelings on either side.
What to Consider When Assessing an Early Retirement Offer
To create a win-win situation for the worker and the company, an early retirement offer has to balance the employer's need to save money with your need to make the emotional and financial leap to retirement.
Here are seven items to consider:
The Package's Worth
Calculate the dollars and cents, but also ask yourself what your offer is worth to you. Together with Social Security and your existing resources, is it enough to sustain you through retirement—or through to your next opportunity? Could it provide seed capital for a new business or supplement your income at a less demanding job?
Retirement Savings, Pensions and Income
Retiring early gives you less time to save for retirement and more time to spend. You'll also have less time for your investments to grow, which could mean less money to tap in retirement and less income every month. Early retirement may also affect your eligibility for pension plans at work or stock option vesting. Before you agree to anything, sit down—preferably with the help of a financial planner—and map out the various consequences of accepting early retirement now.
Learn more: How Much to Save for Retirement by Age
Taxes
Any withdrawals you take from a traditional 401(k) or IRA are taxed as ordinary income. If you're under age 59½, you may also get hit with a 10% early withdrawal penalty from the IRS. You can withdraw money penalty-free from your current employer's 401(k) plan if you're at least 55 when you're separated from your job.
Also note that any money you receive as part of an early retirement package is considered income and is taxable in the year you receive it.
Learn more: How Are 401(k)s Taxed in Retirement?
Social Security
Social Security retirement benefits begin at age 62, though Social Security considers the full retirement age to be 67 for people born in 1960 or later. Here's the catch: Your monthly benefit at 62 could be more than 33% less than what you'd receive if you waited until full retirement age to start receiving checks.
Also, Social Security averages your income over 35 years to calculate your benefits. If you've worked less than 35 years, retiring early could affect how much you receive. If you're unsure where you stand, visit the Social Security Administration website at SSA.gov to set up an account and estimate your benefits.
Learn more: How Much Social Security Will I Receive in Retirement?
Health Care
Medicare eligibility begins at age 65. If your employer doesn't offer continued health coverage, you may have to buy your own insurance. Health insurance can be costly, particularly in the years leading up to Medicare eligibility.
Lifestyle
Retirement brings about major changes in spending and lifestyle. Will you miss going to the office and interacting with coworkers? Can you afford to continue living in your home? Consider how retirement might change your finances, your day-to-day life and your dreams of traveling the world or helping your grandchildren through college.
Learn more: How Much Will You Spend in Retirement?
Alternatives
Think through all of your options before you decide. Is there a secure path forward if you stay with your current employer, or are they likely to eliminate your department or downsize later? Can you find a comparable job elsewhere or pursue a new career path? Can you lower your living costs now to adjust to an early retirement? One way or the other, can this offer work for you? If there are considerations that would make your transition easier, such as continued health benefits, now is the time to ask about them.
How to Ensure a Secure Retirement
If you're considering an early retirement package, securing your retirement has a specific focus. Hopefully, you're already on track: You have money saved and a general plan for budgeting and spending when you're ready to quit working. What you need now is a strategy for accelerating your transition while still having enough income to live comfortably for the rest of your life.
Tip: If you can, consider working with a financial advisor who can help you take stock of your retirement savings, understand the various components of your early retirement offer, project your needs going forward and propose a plan. If you're not financially ready to stop working yet, an advisor can help you figure out what it will take to get you to the finish line.
Frequently Asked Questions
What Is Considered Early Retirement Age?
Early retirement commonly means retiring before you reach the eligibility age for Medicare or full Social Security retirement benefits. Social Security considers the full retirement age to be 67 for people born in 1960 and later. Medicare eligibility begins at age 65.
You may also want to consider these age-related milestones:
- Social Security retirement benefits begin at age 62. However, retiring before full retirement age means your Social Security benefit checks will be reduced. If you retire before age 62, you may not qualify for early Social Security retirement checks at all.
- Early withdrawal penalties apply if you're under 59½. Withdrawals you make from a traditional 401(k) plan or IRA, and some withdrawals from Roth IRA or 401(k) accounts, may be subject to a 10% penalty if you're younger than 59½.
- Pension withdrawals may begin at 55. The IRS allows penalty-free withdrawals from your 401(k) if you've been separated from your job at age 55 or later.
Can You Negotiate an Early Retirement Package?
Yes, you can negotiate with your employer over key elements of your early retirement package. In addition to asking for more money, you can propose alternatives. For example, consider asking for career counseling or help with retirement planning. If you don't need health insurance because you can piggyback on your spouse's work policy, you might ask whether you can redirect that money toward a bigger cash out offer.
What Happens if You Reject an Early Retirement Offer?
You can reject an early retirement offer if the terms don't work for you. You may hang on to your job, but be aware that early retirement offers sometimes foreshadow layoffs to come. There's no guarantee your job will be safe or that future severance offers will be equally generous. Whether or not you accept a buyout, you may want to take your early retirement offer as a sign that it's time to start developing options, just in case.
The Bottom Line
Receiving an early retirement offer may mark the end of a happy era in your career, but also the beginning of new possibilities. Taking an incentive to retire early and pursue a new chapter of life can be a positive, even transformational, opportunity. But, it almost certainly requires a reassessment and recalibration of your current retirement plans, and a new strategy for how you would like to live in the years ahead.