How to make a package payment work for you
So you lost your job and you didn’t get the $434,668 severance package that U.S. Treasury Secretary Timothy Geithner nabbed from his former employer, the New York Federal Reserve Bank. But you probably still walked away with a chunk of money (maybe it was closer to a nugget) that you didn’t have before you were let go.
Assuming your income was a tad less than Geithner’s, who earned $411,200 last year as president of the bank, according to a financial disclosure filing in late January, you may be wondering how to make that severance package last.
First, severance packages are considered taxable income, so be prepared in the event you wind up with a tax bill next year. Also, understand that you’re relatively fortunate if you do get a severance deal. Companies are not required to offer them, though many do provide some kind of compensation.
Marcia Rhodes, a spokeswoman for WorldatWork, an association of human resources professionals, says that 31 percent of employers gave one week of pay for every year of service in their severance package in 2007, the latest year available; 20 percent offered two weeks of pay for every year worked; and 40 percent used some other formula.
With companies expected to continue shedding jobs in 2009—an estimated 2.6 million jobs were lost last year—preserving your pool (or puddle as it may be) is the name of the game.
Curb spending
To stretch those funds, consider cutting your daily living expenses. Reduce or eliminate pay TV programming, suspend your gym membership, ask credit card providers to lower your interest rate, and stop dining out. Suspend contributions to your IRA and to your children’s college savings fund. Forgo the lawn and cleaning service. Cut coupons, shop around for better rates for auto and homeowner insurance, and lower the thermostat to reduce utility bills.
Financial experts tell AARP Bulletin Today that it may take you longer to find another job—on average 3.7 months for workers age 50 and older compared with 3.3 months for younger workers. When you do find work, the salary may be less than what you had been earning.
“These are drastic times, and drastic times call for drastic changes,” says Kelly Campbell, a certified financial planner and founder of Campbell Wealth Management in Fairfax, Va., a suburb of Washington, D.C. “Look at how you can change your lifestyle and tighten your belt. Fixed expenses can be lowered and discretionary expenses can be cut out. Businesses find ways to save money, so you have to think of your family’s economic situation like you’re running a business.”
Boost coffers
Greg Merlino, a certified financial planner and founder of Ameriway Financial Services in Voorhees, N.J., recommends socking away a large part of your severance funds in a bank account so that it can be easily tapped if the job search lasts longer than expected and cash runs thin. He would put the rest of the money into what he called less risky, high-grade corporate bonds, bond mutual funds or exchange-traded funds because their returns are typically higher than money market accounts or most certificates of deposit.
To those who may be tempted to use their severance funds to invest in equities when prices are down, Merlino says, “Don’t.” Your goal should be to beef up your cash reserves, not invest in the stock market or other risky ventures.
Of course, if you have ample savings and snagged a generous severance package, you might want to be slightly opportunistic with those funds, says Tim Courtney, chief investment officer at Burns Advisory Group, Oklahoma City. Buying up shares in today’s bear market, when your money goes farther, could leave you sitting pretty years from now when the market recovers and turns bullish.
“If you’ve got sufficient cash reserves and savings set aside to ride out short-term spending needs and then you land a job and generate income, you may want to put a piece—or most of the package—in the market,” he says. “When we look back on this stock market, this will have been an opportune time to invest in stocks, and it’ll provide a lot of growth in people’s portfolios and fund their retirement spending.”
Don’t pay off debt
Courtney warns against using severance funds to pay off credit card debt unless the interest rates are extraordinarily high and your cash flow is sufficient. Credit card lending is tight these days, so if you pay off credit cards and close accounts, you may find that getting approved for credit later, if you should need it, may be hard.
“Paying down debt will help your debt cash flow because you won’t have those payments, but your liquid severance will be depleted by the amount you put toward that debt,” he says. “If you have trouble finding a job, you might find that you’re backed into a corner and the credit you need won’t be available.”
Thinking about raiding your 401(k)? Forget about it. That money is reserved for your retirement and should only be used as a last resort.
If you do withdraw funds and you’re younger than 591/2, you’ll likely face a 10 percent penalty and pay taxes on the amount you take out. But if you need only a portion of those funds and you’ve been laid off, you could sidestep the penalty by taking out an income stream from your 401(k), Merlino says.
“If you’re 50 and your remaining life expectancy is 28 years, you’d have to take out an amount equal to 1/28th” of the account in the first year, he says. The next year you would withdraw 1/27th, and so on.
Consider entrepreneurship—or not
In the event it takes months, perhaps years, to find work, Merlino says older adults may want to consider using their severance package to realize a long-held dream such as opening a business—if they have other assets to fall back on. That’s especially important, he says, when you consider the high rate of failure among new businesses.
“It’s a dramatic situation for some people who are let go, but for others, it’s a liberating experience, like they’ve been given a new lease on life,” he says. “It gives them an opportunity to pursue a passion that’s been inside them for a long period of time.
“One of my clients loves the shore and opened a pizza place with that money [outside Ocean City, N.J.],” Merlino says. “It’s a small operation, but he always thought it would be a cool thing to do.”
If buying a business is out of the question, and you’re between jobs for a lengthy period, consider regrouping, Courtney says. Think about taking a position that may be outside of your field or working at a job that pays less, because the decisions you make now will have an enormous impact on your retirement years.
“The longer you go without holding a job, and you start to eat away at your nest egg, what happens in that time frame close to your retirement has a magnified effect on your retirement assets going forward,” he says. “The five years before and after retirement have an overly large impact on what your retirement’s going to look like … because of the compounding effect of your investments and savings.
“If you withdraw assets when you should be compounding them, your purchasing power will be severely diminished in the middle or latter part of your retirement.”
By: Carole Fleck | March 17, 2009
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