So you've been laid off or taken the buyout? Here's what you do next

By Gail MarksJarvis

The time has arrived.

Perhaps you never imagined leaving journalism, but now your company is on a cost-cutting blitz and offering a buyout package for anyone willing to head out the door fast. Can you afford to take it?

You need to examine both immediate and long-term needs and skip the wishful thinking.

Affordable health insurance isn’t certain

Your most immediate need will be health insurance, especially if you are still years away from 65, the year you can start getting Medicare. You can’t skip health insurance, and it’s outrageously expensive if you need to buy it on your own. Spending more than $12,000 a year wouldn’t be surprising.

If you will be out of job for a while, how will you pay for it? Is it reasonable to assume you will get another job soon with comparable health insurance? If your employer is going to let you use the company’s health insurance plan for awhile, will it cover a spouse or children?

Some companies tell you that you can buy insurance through COBRA. That means you pay full price – what you typically have paid plus what the company has paid. COBRA legally runs out in 18 months, although some employers let early retirees keep the insurance if they will pay the full price indefinitely.

Even if your employer has offered you some health insurance benefit once you leave your job, you cannot count on it, says Chicago employment attorney Mark DeBofsky. Although your buyout package might seem iron-clad, there is usually language in the documents that will let the company change, or even eliminate, health insurance. And with health care costs rising far in excess of inflation, there’s certainly an inclination by companies to tinker.

That means you could incur higher living expenses than you might first envision, and in your 50s you could have trouble qualifying for affordable health insurance.

Language in buyout packages – whether related to health insurance or other provisions – can be complex. It’s worth having an employment lawyer take a look. You can find such an attorney at www.nela.org.

This is especially important if you might have any potential legal issues pending. Typically, when you take a buyout, you waive your right to any action such as a discrimination claim, says Chicago employment attorney Michael Karpeles.

Before signing the buyout agreement, he suggests getting, in writing, what will happen if a suit arises involving a story you’ve written. (Who will pay lawyer fees?) And go over your access to stories or photos that might be copyrighted. Karpeles also suggests getting an agreed upon letter of reference and a written commitment about what your employer will say if your references are checked.

Do a household budget

If you are years away from collecting Social Security, and have a stash of money you plan to live on while looking for another job, make sure the numbers really work. This is especially important if you are going to be picking up substantially higher health care costs.

For help in putting together a budget, go to http://www.kiplinger.com/tools/budget/index.html.

As you think about spending money, it will be wise to keep the buyout money off limits.

Most Americans haven’t saved enough to last them through retirement. So anything you get from the buyout, especially if you will be out of work for awhile, should go into retirement savings. If you can roll all the money into an IRA, that would be ideal because it will be sheltered from taxes.

If you want a quick look at how well you’ve set yourself up for retirement so far, try the “ballpark estimate” calculator at www.choosetosave.org.

If you are thinking of the buyout as “early retirement,” and you don’t plan to work, be cautious about dipping into Social Security at age 62 – especially if there are good longevity genes in your family. Married people must consider a spouse’s longevity too. Each generation lives longer, and already about 40 percent of married women live to 90. Women are more likely to spend their late retirement in poverty than men because they live longer, and savings are often spent down paying for the man’s medical expenses.

That means it’s important to plan for 25 to 30 years or retirement. And receiving as much Social Security as possible will be critical. So, as a rule of thumb, it’s wise to delay taking Social Security early. If you can delay until age 70, that’s even better.

To see what your retirement age will do to your monthly Social Security check, try the Social Security calculators at www.ssa.gov/planners/calculators.htm.

Taxes will play with your future

To maximize the growth potential of your buyout money, you will be best off if you roll it directly into an IRA without paying taxes up front, says Charles Farrell, a Denver financial advisor.

If you instead take a lump sum distribution in cash, you will lose a chunk on taxes immediately and that will erode your ability to earn a return on a large amount of savings.

Here’s an illustration. Imagine you earn $75,000 a year, and receive a year’s pay in the buyout. If you roll it all into an IRA, and invest it in a diversified portfolio of stock and bond mutual funds, you will start earning a return on $75,000 immediately. You won’t pay taxes until you begin withdrawing the money for retirement living expenses.

If you instead take $75,000 in a lump sum distribution in cash, you will lose about 30 percent immediately in taxes, estimates Farrell. So instead of earning a return on $75,000 in investments, you will earn it on only $52,500. And if you don’t shield the money in an IRA, you will pay taxes on the earnings each year.

Farrell calculates that if you took the lump sum in cash at age 55, and earned a 7 percent annual return on your investments, you’d have about $96,715 by age 65. If at the outset, you had instead rolled the $75,000 in buyout money immediately into an IRA, you would have accumulated $147,536. (That assumes the same 7 percent annual return on both investments.)

Taxes are so important you may want to consult a certified public accountant or a certified financial planner with a strong understanding of tax implications.

Look at how the buyout positions your future

Let’s say you are 55 years old now, and trying to figure out if you can afford retirement and leave work now with the buyout offer. Here’s the thinking process.

Say you have been making $75,000 a year, have $350,000 saved for retirement, and can add another $75,000 from the buyout to that amount. That means at 55, you will have $425,000 for your future. You are going to invest the entire sum, and that instant $75,000 you’ve picked up in the buyout, means a lot. If you didn’t have it, and continued working, Farrell calculates you’d have to save and invest about 12 percent of your pay --$9,000 a year -- for about six years to accumulate about $75,000 in savings.

With the $425,000 invested at age 55, you get a head start. You will accumulate about $836,000 by age 65 if you earn a 7 percent return annually on your investments. (You can do an easy calculation with your own buyout money using the compounding calculator at www.moneychimp.com).

But what do you do when you see the sum? Is $836,000 a lot of a little for a retirement of perhaps 30 years? When you retire there is a rule of thumb about using your savings. You can only withdraw 4.5 percent from your nest-egg the first year of retirement, and then increase the sum 3 percent a year for inflation. If you remove more than that, you are likely to run out of savings at some point during retirement.

So with $836,000 in savings you will be able to spend $37,622 the first year of retirement, and $38,750 the second year, according to Farrell. That probably looks like a pitiful sum. But it’s not quite as bad as you might think. If you add $18,750 from Social Security and $12,000 a year from a pension (if your employer offers one), that’s a total of $68,372 a year in living expenses.

In other words, if you were used to living on $75,000 a year, you would be able to replace less than 68 percent of your usual expenses. That’s risky, says Farrell. As a rule of thumb, financial planners want you to be able to replace at least 70 to 80 percent of the last annual salary you earned on the job.

So Farrell said he’d be reluctant to retire at 55 under such circumstances.

But what could you do? If at 55, if you knew you could get another job paying $75,000, and you saved and invested 12 percent ($9,000) a year for retirement in a 401(k) until age 65, you would accumulate about another $150,000 in savings. So along with the other savings you previously calculated, you can now count on total of $986,000.

Under that scenario, you’d be able to replace about 81 percent of your typical $75,000 income. The picture would look like this:
- $44,374 from savings
- $25,198 from Social Security (which would be higher than your first estimate because you worked for another 10 years)
- $12,000 from the company pension
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Total $81,572 for living expenses.

To try to do similar calculations using internet calculators, try
http://www.finance.cch.com/sohoApplets/RetirementIncome.asp or
http://cgi.money.cnn.com/tools/retirementplanner/retirementplanner.jsp. For the more advanced version, which will make you think more deeply about your spending plans, try http://calculators.aol.com/tools/aol/retire02k/tool.fcs

Keep in mind that if you are planning for a period that is years away from now, thinking about replacing today’s pay won’t be enough. Inflation will be undermining your buying power. So if inflation runs 3 percent a year, you will actually need about $100,000 to equal today’s $75,000. This chart will give you a look at the impact of inflation on your pay. http://www.nylim.com/retirement/0,2058,30_1010606,00.html, or play with this calculator https://www.elcabop.org/Calculators/inflationcalculator.aspx.

Gail MarksJarvis is a personal finance columnist at the Chicago Tribune and the author of “Saving for Retirement without Living Like a Pauper or Winning the Lottery.”

Posted July 1, 2008