VSP: Yay or Nay?
Photo by Matt Walsh on Unsplash
Have you received a Voluntary Separation Program (VSP) offer? We recently had several clients be offered this so it’s fresh on our minds.
When an offer like this happens, it can naturally cause a lot of questions both financially and emotionally…
Am I financially ready to retire?
What happens to my health insurance?
How would I access my money before age 59½?
What will I do with my time if I retire?
Is this a once-in-a-lifetime opportunity or will another chance come along later?
Those are all good questions. And while every situation is unique, there are some common themes we encourage people to think through before making a decision.
First: Don't Make a Decision Out of Fear
Let's start with something simple.
You don't have to take the VSP.
That may sound obvious, but when an offer arrives with deadlines attached, it's easy to feel pressure about what needs to be a quick decision.
If you're unsure about the timing, unsure about your finances, unsure about being emotionally ready, you don't have to move forward. Even if it seems smart otherwise.
You might find it much more satisfying to leave on your own terms later. It might be helpful to take some time, perhaps the next few years, to test whether you're truly ready for retirement.
But the reality is that there are no guarantees either way.
Maybe there will be layoffs after this.
Maybe another VSP is offered in the future.
Maybe this is the perfect opportunity.
Maybe none of those things happen.
Nobody knows.
That uncertainty is exactly why we don't think fear should be the deciding factor. The better question is whether accepting the offer aligns with your financial situation, your goals, and your vision for the future.
The Financial Question
Of course, the main question people often ask when offered something like a VSP is “Do I have enough money to retire?” If you don’t have a financial planner to help you crunch the numbers, it can be hard to truly know.
Spending Capacity
A key piece to the decision is figuring out whether you'll be able to sustain your lifestyle during retirement. When working with our clients, we go through an analysis to determine their "Spending Capacity", and I recommend you do the same.
What's your Spending Capacity? It's how much you can spend, taking into account all your resources, balancing being prudent with allowing yourself to have fun. What are the different components? The big one is your investment assets. Your CRSP. Your IRAs. Your taxable brokerage accounts. Your bank accounts. Etc.
Then you can layer in Social Security benefits for yourself and, if applicable, your spouse. Of course, when to claim Social Security benefits is a factor to consider too.
Then you can layer in other income sources. Maybe it's a pension. Maybe it's rental income. Maybe you'll have a side gig after retirement that brings in some dough.
Then you can layer in any known (or suspected) large expenses. For example, long-term care. Major home renovations. A vacation home. Perhaps you'd like to make sure that you leave a large sum of money to your kids. Put it all together, and we can calculate your initial Spending Capacity during retirement.
But then, and this is key, you need to be ready to make future adjustments as life throws curve balls at you.
Now, this is all easier said than done. It's a blend of art and science. With the math portion being admittedly difficult to calculate.
Adjustment Plan
Once you determine your Spending Capacity, then you need to figure out your adjustment plan. Why?
Well, there's this thing called life. It tends to throw curve balls.
They may be good curve balls. They may be bad. But they will come.
Your adjustment plan tells you when you need to change your annual spending. For example, there might be a major stock market crash. Or you have several huge expenses you weren't expecting. At some point, it's going to be prudent to lower your spending.
That's called hitting a "lower guardrail".
On the other hand, maybe things will turn out better than expected. Maybe there's a bull market. Or your spending is lower than you planned. At some point, you should be able to give yourself a raise.
That's called hitting an "upper guardrail".
The point is to have a plan in place ahead of time. That way you know that whatever comes along, you can adjust and be okay. This is exactly what we do with our retired clients … figure out their initial Spending Capacity, and agree to adjustment thresholds for when life happens. We also can look at different scenarios in history to see how the financial plan would done, for example, how many spending reductions would have been required for your plan if you retired at the beginning of the Great Depression.
High-Level View
Let’s zoom out to the 10,000 foot view of analyzing a VSP offer:
Determine your current spending level.
Think about how your spending level might change during retirement. Many costs might go down, but others might go up (like health insurance premiums). Also consider big one-time or very occasional costs.
Determine how much spending your assets can provide (your Spending Capacity, as discussed above).
Compare the numbers from #2 and #3 to decide whether you’re financially ready for retirement.
Also think about the emotional aspects of retirement readiness. Are you truly ready?
The most difficult of these questions are probably #3 and #5.
For #3, this is really tough to do without financial planning software, as discussed above. But as a starting point you can look at “the 4% rule” (withdrawing 4% of your investment portfolio in the first year, then adjust it for inflation each year).
For #5, well that takes a little more soul searching and can be the hardest question of them all, which we will talk about below.
The Technical Questions
Let’s also look at a few technical questions that are worth thinking through.
Withdrawal Timing
But Keith, what if I’m not 59 ½ yet? How will I get to my money?
If you’re under that age, you might be wondering about this.
After all, if you withdraw money from your retirement plan before the magic age of 59.5, you might be subject to a 10% early withdrawal penalty. Yuck. And that’s in addition to normal income taxes. Double yuck.
The good news is that you're not stuck. There are a few options available to you.
Taxable accounts: You can withdraw money from taxable brokerage accounts or bank accounts until you turn 59.5. This is the most straightforward method, and is one of the reasons I think having substantial sums in taxable brokerage accounts is so great.
Rule of 55: This is an exception to the 10% penalty that allows penalty-free withdrawals from a previous employer's 401(k) if you leave that job during or after the calendar year you turn 55. Note that this applies ONLY to 401(k)s, not IRAs.
Rule 72(t), aka SEPP: This is another exception to the 10% penalty, where you take money from a retirement plan in "substantially equal periodic payments" (SEPP). This is available to everyone regardless of age, but you must take those regular payouts for at least five years or until you turn 59½, whichever time is longer. This is the least flexible option, because once you start, you cannot modify the payment stream, although there are planning techniques to increase the flexibility of this option.
Pay the 10% penalty: I'm not exactly a fan of this option, but, hey, it's an option. This might be reasonable if you need to make a relatively small withdrawal and don't want to deal with the complexity other options.
Roth IRAs: You can take withdrawals from your Roth IRA penalty-free before 59.5, but only up to the amount of your contributions (and conversions, if more than 5 years ago). The main downside is that you give up all the future tax-free growth that Roth accounts provide, so I’m not crazy about this option.
Other: There are other, more limited, options to consider too, such as if medical expenses > 7.5% AGI, paying health insurance while unemployed (IRA only), disability, birth/adoption ($5K), higher education (IRA only), first home ($10K, IRA only), etc.
Health Insurance and Long-Term Care
It’s important to factor in a few health-related costs into your spending.
If you get your health insurance through your employer, it’s probably being subsidized pretty heavily right now, so your out-of-pocket costs are currently quite low.
That's sure to go up if you retire before Medicare eligibility (age 65).
One option is your state's health insurance exchange. In my personal experience since leaving a large employer and starting my financial planning firm, I've found the state health insurance exchange to be a pretty good experience. Sure, perhaps not as good as a top-of-the-line insurance policy through an employer, but it has covered my family's needs.
Another option is to go on COBRA. With this, you'll stay on your current plan, but you'll have to pay the FULL premium, which is likely quite hefty, plus a 2% administrative fee. You can stay on COBRA for up to 18 months after your leave work in most instances.
Another intriguing option is that you might be eligible for your employer’s Retiree Health Plan. There are age and service requirements, but there's a decent chance you may qualify.
The bottom line is that there are options. And you need a plan. So make sure you factor that into your analysis.
Another one is long-term care (LTC). There are three main ways we discuss with clients to plan for long-term care:
Build it into your retirement spending numbers, essentially assuming you’ll need X years of LTC toward the end of your life.
Purchase LTC insurance.
Treat your home as your LTC fund, being willing to sell it (or otherwise access the equity) if needed.
There are pros and cons to each approach, so there’s no “right” answer. The best option for you could be any or all of the above. But I do believe it’s important to consider it and build it into your plan.
The Hardest Question
The financial question can be the biggest question to understand, and the technical questions can feel complicated, but it could be argued the hardest question to answer is, “Am I ready to retire?” Like truly ready. Retirement is a huge transition and should not be considered lightly.
What will you do during retirement? You should be retiring TO something, not just FROM something.
Are you prepared for the loss of the tangible benefits of working? Such as coworkers/friends/social aspects, having a purpose, recognition, daily structure, working with a group towards a shared goal, and so many other considerations?
On the other hand, there are very real advantages to retirement. Such as more time to pursue things you enjoy, time with people you love, volunteering, enjoying travel and experiences while your health allows, less structured time and demands, less stress, and so much more. You might find that retiring earlier might be…
EXACTLY
what
you
need.
In the end, a VSP offer, even if it makes sense on paper with the numbers, also needs to make sense for you personally. And sometimes this can be really hard to know for sure, and maybe impossible to know until you try one way or the other.
The Bottom Line
Whether you should accept a VSP offer isn't a question that can be answered with a simple yes or no.
It involves finances, health insurance, taxes, retirement income, market risk, long-term care planning, and perhaps most importantly, your own readiness for the next chapter.
The right answer isn't the same for everyone.
But we do believe the decision deserves thoughtful analysis, honest conversations, and a plan that's built around the life you actually want to live.
After all, retirement is one of the largest transitions you'll ever make. It's worth doing more than a back-of-the-napkin calculation before making the leap.
We love walking alongside our clients when these types of decisions come up. We can obviously help with the numbers, the analysis, the plans yes, but we also love being a thinking partner and helping our clients ask and answer the hard questions too.
Whether you’re taking the VSP or not, if you’d like someone to join you on this journey of life to help with things like this, you can start the process by scheduling an Intro Conversation here.