Buyouts. Career feds anywhere near retirement eligibility can rival Indiana Jones in their determination, skill and daring in hunting this treasure.
But, in reality, buyout offers are more like “Let’s Make A Deal” than “Raiders of the Lost Ark.”
This game show is actually instructive in some of the fundamentals of probability and decision-making.
In playing the game, contestants face a series of decisions in which they must choose to keep or trade a “bird-in-the-hand” for another prize hidden behind a curtain or in a box — a “bird-in-the-bush.”
When you are offered the opportunity to retire with incentives, like cash, you are faced with this decision. Your bird-in-the-hand is your current retirement plan. For example, you might have worked out a plan to work three more years and then retire on your annuity and accumulated savings. Then, your employer comes along and offers you new options: birds-in-the-bush. Your task is to decide whether those birds-in-the-bush are worth more than the one you already have in your hand.
Obviously, if you were ready to retire anyway, retiring with an extra cash payment is a nice bonus. Retirement with an extra $17,000 — don’t forget that you’ll owe taxes on that $25,000 Voluntary Separation Incentive Payment — in your pocket is clearly worth more than the same retirement plan without the extra money.
However, it can be a much tougher decision, if accepting the buyout requires you to retire significantly earlier than you had otherwise planned.
I have conducted analyses and advised many federal employees considering early retirement over the years. Many of my clients are surprised to learn how much private-sector income from a post-retirement job is required to make up for the loss of federal retirement income that goes along with an earlier-than-planned retirement. In a recent case, we determined that it would take a 25 percent increase in pay over nine years to recover the retirement standard of living lost by leaving federal service five years early.
In my experience, people tend to let emotion drive the decision. Maybe they want to leave their job, so they focus on finding arguments that support this decision — a kind of “shoot now, ask questions later” approach. This approach brings with it bias in favor of accepting the buyout. The bias makes an incentive payment seem larger and the sacrifices smaller than they really are. Couple this emotional bias with a dearth of the analysis needed to support informed decision-making, and you wind up with decisions that seem good today, but mean disaster down the road.
Remember that retiring early is trading one plan for another. If you’ve done it right, your current retirement plan will support a standard of living that you find attractive. In deciding whether to trade this plan for another, you need to consider how the new plan will affect that standard of living. Leaving early may improve your standard of living for the next few years, while you enjoy a different job or not working at all, but what about the effects in 10, 20 or 30 years?
The primary price for retiring early is usually a reduction in annuity income. Whether you’re covered by the Federal Employees Retirement System or Civil Service Retirement System, a federal annuity is hard to beat, and you should be reluctant to give up each and every dollar of it. Based on my experience, it takes at least $16 in properly managed investment assets to replace each annuity income dollar. This means that the $25,000 buyout you receive, after you pay about $8,000 in taxes, can only be expected to replace, at most, about $1,000 per year in inflation-adjusted, annuity income.
There are situations where taking an early out, with or without a buyout, makes sense. There are no reliable rules of thumb for making this decision, however, and my advice is that, unless you are ready to retire without the incentives, you should decline the offer unless and until a thorough and competent analysis proves it to be in your best interests.