PLENTY OF FACTORS TO CONSIDER BEFORE EARLY RETIREMENT
Taking a voluntary package may be risky for some employees, Jason Heath says.
The pandemic lockdown and resulting recession have led to a surge in voluntary severance offers for those approaching retirement. As employees contemplate their options, there are four key considerations before and after signing on the dotted line.
SEVERANCE TERMS
Accepting an early retirement will result in a voluntary severance payment. The payment is generally based on a predetermined number of weeks of salary paid for each year of an employee’s service.
Severance paid due to a voluntary early retirement may be more generous than an employee might be entitled to if their position was terminated otherwise. An employment lawyer can advise as to what a reasonable entitlement might be for a specific employee and whether the severance terms are appealing.
A severance may be paid in a lump sum or as a salary continuance over time. A significant lump sum payment may cause an employee to pay a significant amount of income tax when added to their other income for the year. Sometimes there may be an option to defer the severance or a portion thereof to a future tax year, or have payments made over several years. This may result in less tax payable.
An employee who receives a lump-sum payment may have only 30-per-cent tax withheld, as this is the required withholding rate for payments over $15,000. Given that top tax rates in several provinces exceed 50 per cent, a recipient should budget for the incremental tax payable and consider tax reduction options such as RRSP contributions.
Salary continuance, whereby a salary continues to be paid regularly over the duration of the severance period, can also result in tax minimization. Salary continuance may enable ongoing pension contributions to increase a future pension.
LOSS OF BENEFITS
Salary continuance can also allow an employee to be covered by an employer’s group insurance benefits during the payment period. Regardless, the end of employment will generally result in the end of an employee’s benefits coverage at some point, unless there is a retiree plan offered. This is often a concern for potential retirees. Private health insurance policies are an option but so is self-insuring.
When you are a member of a private plan and paying your own premiums, you may be less likely to receive more reimbursements from the insurer than you are paying into the plan. This, coupled with the maximum annual coverage limits, may cause some retirees to consider simply paying for their health-care costs themselves and forgoing coverage. There is also government coverage for seniors for prescription drugs that varies by province.
COMPANY PENSION AND SAVINGS PLANS
Employees who have a pension plan at work may have a significant decision to make upon leaving their employer.
Defined benefit (DB) pension plans pay a monthly benefit to a pensioner. Payments can generally begin between age 55 and 65. Beyond choosing when to start a pension, there may be payment options as well, such as survivor options for a spouse upon a pensioner’s death.
Some retirees may be able to elect to take a lump sum commuted-value payment to forgo their future DB pension payments. Some or all of this payment will be eligible for a tax deferred transfer to a locked-in retirement account, but some may be subject to taxation in their year of the payment.
Commuted value payouts are not available to all pensioners, and the decision to forgo a guaranteed monthly pension can be a substantial one.
Employees with defined contribution (DC) pension plans may be able to transfer their plan to a locked in retirement account at another financial institution or leave the plan in place with the current provider. Fees for retiree investment options may be competitive compared to external options.
RETIREMENT PLANNING
For those who are ready to retire, one challenge is determining the timing of pensions. In addition to DB and DC pensions that can be started immediately or delayed, there are government pension options to consider as well.
A retiree who is 60 or older has the option of beginning one or both federal government pension plans. Canada Pension Plan (CPP) retirement pension can start as early as age 60 or as late as age 70. Old Age Security (OAS) can start as early as 65 or as late as age 70. The later a recipient begins their pension, the higher the monthly payments. Both pensions have nuances.
For those who are not sure if they can afford to retire, it can make a voluntary severance package that much riskier. Despite the attractive terms, if an employee is not yet financially independent, or unable to easily replace their income while they continue to work, an early retirement may risk a reduction in their retirement lifestyle. Retirement planning should include a thorough assessment of all retirement income sources and expenses, as well any remaining debt or planned asset sales, like home downsizing plans.
Jason Heath is a fee-only, advice-only certified financial planner at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.