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Evaluating an Early Retirement Incentive Offer

Most workers assume they will decide when to retire. Sometimes, however, an employer suggests it in the form of an early retirement (a.k.a., "buyout") offer. Buyouts often include enhanced pension benefits, lump sum cash payments, and/or continued group health insurance coverage. A typical offer adds two to five years of age and service credit to pension benefit formulas so that workers receive about the same amount they would have received at the employer's normal retirement age.

Employers, in both the public and private sector, offer early retirement incentives to save money, usually during economic recessions. They also want to be good to employees and minimize damage to morale, which is why they provide buyout benefits instead of just a pink slip. Many employers require employees who accept a buyout to sign a release saying that they accept the package in exchange for agreeing not to file an age discrimination lawsuit.

Usually workers have only 45 to 90 days in which to decide to accept a buyout offer. Key factors to consider include: attractiveness of a buyout offer, financial stability of the employer, other employment options, access to health insurance, job enjoyment and stresses, emotional readiness for retirement, and payment methods.

When confronted with an early retirement offer, the first question that people generally ask is "is this really a good deal?" There are usually trade-offs with every type of offer, including forgone earnings and bonuses if one retires early and employer life or health insurance that may need to be replaced out of pocket. It is possible to calculate the costs and benefits with a financial calculator using present value analysis to determine a worker's net gain or loss.

Present value analysis calculates today's value of money that will be received in the future. A simple example of present value analysis is when lottery winners calculate the current value of their series of 20 future prize installments to decide whether taking the money as a lump sum or as an annuity is preferable. Two key factors in present value analysis are the discount rate (reverse compound interest) at which it is assumed money will grow and the time period in the calculation.

In calculating the value of an early retirement offer, one can place a present value on the benefits to be received during the time period between the buyout and planned retirement age (e.g., early pension benefits and/or lump sum payments). The next step is to but a present value on benefits that are lost by retiring early (e.g., lost earnings, salary increases, and bonuses). The costs and benefits are then netted together to determine the value of the buyout offer to an employee.

For example, let's assume someone is considering a buyout offer at age 60 versus continuing to work to age 65. The present value of lump sum payments and pension payments (over five years) equals $50,000 and $150,000, respectively. This is a gain of $200,000 to the employee. On the other hand, the present value of lost earnings and lost raises is $220,000 and $10,000, respectively, plus the present value of premiums for replacement health insurance that must be purchased during the five years of early retirement is $20,000.

In this example, early retirement is not a good deal in strictly financial terms. The net cost to the employee is $50,000 ($250,000 in costs and losses minus $200,000 in added income). In other words, the worker will have less by taking the buyout than by continuing to work.

This analysis assumes that the worker's job and future raises are predictable, which is not always the case, however. Sometimes it is better to take a buyout offer than to be laid off without any additional payments. The analysis also assumes total retirement. Many early retirees, however, walk away from one job and quickly find another. Other factors to consider in a buyout decision are personal health status and the value placed on being able to control one's use of time.