Dear Ms. MoneyPeace:
I have a question for you, and I would prefer a yes or no answer. When I am “termed” later this year, I’ll have about $150,000 in cash between service-termination money and savings, and will owe around $70,000 on my house. Should I just go ahead and pay it off? It is my only debt, and I am 59 years old.
I love yes-or-no questions, but this is not one. After 30 years of being a financial professional, I have learned that personal-finance decisions have a complex set of variables.
Severance can bring peace of mind with the right planning but so much depends on the individual. Do you have another job lined up? Are you intending to work? Fully retire? Or start a business? Do you have upcoming family costs, such as college fees?
Plus you must understand the payment you are getting from your employer and how to best make use of the funds. In addition to your typical paycheck, you may be getting paid time off, or PTO, and severance pay.
According to Heather Rider Hammond of Gravel & Shea PC in Burlington, Vt.: “Severance pay is compensation paid to the employee on a post-employment basis. It is not payment for services rendered, so it is not considered to be qualified compensation.”
Therefore, it is important to establish amounts and the timing of these last checks and do some cash planning.
There are five areas to pay attention to before making your final decision:
Assess cash-flow needs: Depending on what you are doing, your future cash needs vary. For example, with creating a business, there are always startup costs. Set aside enough for those costs, as well as some cash to live on as you get the business going. If searching for another job, you also want cash until your next paycheck arrives.
If you are retiring, keep cash to live until 2023. Starting retirement withdrawals in the new tax year will save you income taxes. More importantly, the time lapse will give you a realistic idea of your monthly cash needs post-work to set a monthly retirement monies disbursement.
Establish important cash accounts: A safety account is mandatory to good financial planning for everyone, even if you are retired.
In addition, set aside some money for potentially large expenses: your next car, major work around the house, medical expenses. This one-time lump sum is a rare opportunity to establish your future stability.
Check in with human resources: Discuss with them your options and make the following changes.
• Increase retirement contribution to reach the max before termination: At your age, you can put in $27,000 this year. (The maximum before age 50 is $20,500.) However, this increase cannot be made with your severance money, only your qualified earned payroll check. According to Hammond: “It is possible for a departing employee to defer her ‘last paycheck’ (including her PTO payout) to her 401(k), but not severance payments.”
• Adjust your health savings account: If you have one at work, max it out, like your 401(k), before you terminate employment through payroll deduction for the pre-tax benefit. For you, this means $4,650 (with a $1,000 catch-up) and $8,300 for a family (with a $1,000 catch-up). Once again, this cannot be done with your severance money so plan your last paycheck contributions accordingly.
• Ask about the following options:
Can you receive your payout in installments? Getting your payout over two years may save you income taxes. This is at the employer’s discretion if there was a layoff, but typically not if there is a business sale or merger.
Contribute some sick time or vacation time to a work bank? This voluntary system is offered at a small number of companies. You would forgo the income but would lower your income (and taxes) while doing good for someone else.
Pay on any 401(k) loans, insurance or other benefits only offered through work?More deductions mean fewer expenses moving forward, and some may still be considered pre-tax contributions.
Talk to your accountant (or consult one): They will know if this severance will boost you into another tax bracket and how best to adjust your W-4 now so you will not get a surprise come next spring. Also, they will be able to tell you if you qualify for funding an individual retirement account. Funding a Roth or traditional IRA for 2022 and for 2023 allows for your money to grow tax-free. If you have the option for a traditional IRA, then it will be tax-deductible. Since you are over 50, you can put away $7,000. (The limit is $6,000 for those under 50.)
Other considerations: Check with your state department of labor to determine if you qualify for unemployment. Each state has different rules.
If you do get paid severance in installments over 2022 and 2023, this may give you more options to put aside money for retirement and save on income taxes. This will also potentially delay your ability to collect unemployment.
After gathering the above information, you can decide what is left and put that toward your mortgage. Just remember that you will still owe home-insurance premiums and real-estate taxes annually.
Being laid off stirs emotions, and none of us makes the best decisions under stress. (Hans Seyles proved the physiological impact of stress on decision making in the 1930s.) If you choose to delay a decision on a mortgage payoff until a couple of months into your new life, this is understandable and wise.
Also on the emotional side, paying off a mortgage always feels good wherever you are in life or the world. It is a sound financial strategy. (Here I see Col. Potter on “M*A*S*H” burning his mortgage paperwork in Korea.)
Just don’t ever reduce your life or major decisions to black and white. All good decisions come to those who wait and have all the information.
CD Moriarty is a certified financial planner, a columnist for MarketWatch and a personal-finance speaker. She blogs at MoneyPeace.