Taxes on a Severance Package

*Answer Provided by Bud Hebeler*

Thank you for asking. I can't see the future any better than anyone else, but you might consider the following:

1. See if you can pay back your Social Security so that you can restart at a later age. I believe that you can do this still if it has been less than a year since you started. You'll never be able to buy a commercial annuity as cheaply as you could using the same amount of money that you'll use while waiting for a later start of Social Security payments.

2. Find a competent CFP from www.napfa.com in your area and get some advice. He/she will help you with more than investments because he/she will also consider your insurance and estate matters. Ask his/her opinions of the following actions after you've paid the rather large income tax, Social Security tax and Medicare tax on the severance pay:

3. With the economy the way it is, I'd invest much of the severance money in several different bank's CDs so that all of it is FDIC insured. I would not invest in a municipal bond fund because interest rates are likely to rise and thereby reduce the amount of the principal in the account.

4. Put about 20% of your investments in tax-managed Vanguard stock index funds.

5. You might consider laddering immediate annuities by investing a small amount of the severance settlement in each of a number of succeeding years.

5. If you have any qualified accounts (401(k), IRS, etc.) consider rolling them over into Roth IRAs. You'll have to pay income tax on the amount of the rollover, but this is probably the best tax protection you can get. Then invest the Roth money with equal amounts in a REIT from Vanguard or Fidelity, 1, 3 and 5 year CDs and a 5 year TIPS bought at auction (no fees) through a broker. When the CDs mature, use the money to buy more 5 year TIPS.

The actions above are the kind of things I've done personally. Hope this helps.

Disclaimer: These materials are provided by Analyze Now as a service to its customers on an "as is" basis and may be used for informational purposes only. Analyze Now assumes no responsibility for error or omissions in these materials. Analyze Now makes no commitment to update the information contained herein. Analyze Now makes no, and expressly disclaims any, representations or warranties, express or implied, regarding the Analyze Now web site, including without limitation the accuracy, completeness, or reliability of text, graphics, links, and other items accessed from or via this web site. No advice or information given by Analyze Now or any other party on this web site shall create any warranty or liability.
Analyze Now does not warrant or make any representations regarding the use or the results of the use of the materials in this site or in third-party sites in terms of their correctness, accuracy, timeliness, reliability, or otherwise. Under no circumstances shall Analyze Now or any of its respective partners, officers, directors, employees, subsidiaries, agents, or parents be held liable for any damages, whether direct, incidental, indirect, special, or consequential damages, and including, but not limited to, lost revenues or lost profits arising from or in connection with the use, reliance on, or performance on the information on this web site. The situs and venue for any claims, disputes, actions, or suits regarding this disclaimer and limitation of warranties shall be King County, Washington State.

These are questions that are asked frequently. Unfortunately, most of the material in retirement planning assumes that you choose one allocation, take out some percentage the first year, say 4%, and then adjust the amount upward for inflation each year until you die.

That may be OK for an estimate of how much you should save for retirement, but it’s obviously not the way you would want to blindly manage your finances in the future. First it assumes that you will not get more conservative as you age. Next it assumes that the investments will go steadily up or, with Monty Carlo programs, will behave in a statistical pattern as investments performed in the past. Older folks who retired in the late 1990’s will bear witness to that fallacy.

There are not many 80 year olds who would feel comfortable with a stock allocation that was the same as would be recommended for those who were in their 60’s. Most 80 year olds are more concerned with getting a steady income than expecting to get rich, while the 60 year olds still may be wearing rose colored glasses expecting to get 10% returns from their own judicious selection of stocks.

Retirees who have lived through a severe stock market drop know that they cannot continue to draw down the same amount from their stocks as they did before the plunge in market values. And they certainly are not about to increase their withdrawals by the amount of inflation. This last decade of very small returns from the stock market and even lower interest rates from bonds has stressed retirees on both ends of the stock/bond allocation extremes—as well as those in the middle.

Many users of the planning material on www.analyzenow.com write me about how well they have done in spite of the poor economy and my long-standing advice not to count their home as a retirement investment. They don’t say they got rich, but they have not suffered like so many retirees. The site has always recommended both conservative security allocations and a conservative withdrawal approach.

My allocation formula is simple, modeled after the old fashioned age-related approach that was maligned by so many professionals years ago as being too conservative. Now those same pundits are eating a lot of crow. My formula for the stock allocation percent is just 100 less the retiree’s age. The rebalancing should be whenever the stock values drop below that percentage or grow beyond 10% higher than that percentage. I’ve found that I’ve had to rebalance only about every other year.

I certainly do not increase my retirement budget by inflation every year. Instead I calculate a new budget at about the time I do my income tax every year. That’s convenient because I have all of the numbers in front of me at that time—and it’s also the time of year when it’s raining outside in Seattle, so I’m more likely to be house bound. I don’t spend a lot of time either on investing or fretting when I should recalculate a new budget. My budget calculation always includes an update of my replacement budget (see www.analyzenow.com) and something for emergencies, so those give me a little cushion.

The baby boomers are going to face a tougher economic time than the boom years after I retired more than twenty years ago. They are going to bear the brunt of (1) current excessive government spending, (2) much less savings than previous generations and (3) the results of an aging population that demands more expensive medical services and where there are less workers to support Social Security, Medicare and government pensions. It’s a triple whammy that is inevitable. There are no magic bullets that can get rid of the exponential growth of government debt and baby boomer overconsumption of the last two decades or that can make us younger. These are all cumulative effects that aren’t considered by the overly optimistic economists attempting to make us feel good and spend more so that their employers can make more money or the gover