Author Topic: Severance pay - take pay-out now or pay on (early) retirement?  (Read 6184 times)

Dee

  • Pencil Stache
  • ****
  • Posts: 748
  • Location: Ottawa, Canada
Iím looking for input to make sure I consider all relevant factors and approach the matter as rationally as possible in making a financial decision.

Iím a federal public servant (in Canada) and one of my benefits is changing. Whereas before, I had severance benefits accruing that would be paid out when I left the public service (regardless of the reason for leaving, including resignation and retirement), now the severance only keeps accruing for lay-offs. But, for any severance amount I have already accrued, I now have the option of having it paid out now (at my current salary) instead of when I leave the public service (at whatever salary I make at that point).

In my case, the amount  I accrued is worth about $16,000 now. I have three options:
1. cash out this accumulated amount immediately;
2. have the severance paid out when I leave the public service (likely to be an early retirement in 7-10 years, in my case) at an amount based on whatever rate of pay I make at that time; or
3. cash out part of the sum now and part of it on leaving the public service.

If I cash out now, the amount would be taxable at a marginal rate of approximately 45%. Given this, if I took the pay-out now my intention would be to shelter it in my RRSP. I have enough contribution room for the entire amount. (N.B. to put an amount up to $10,000 into an RRSP just requires declaring to my employer I have the contribution room, but to put any amount beyond $10,000 into an RRSP requires getting pre-approval from the Canada Revenue Agency.) (N.B if anyone wants to make points I havenít thought of in favour of cashing money out now and not putting it in an RRSP, Iím definitely open to considering that as well. It just hasnít seemed advantageous based on what Iíve thought about.)

From what I gather, figuring out how to get the most amount out of the money requires making assumptions about the future. I think the point would be to compare what I think the money would be worth when I leave the public service if I took the pay out now and invested it vs. what it would be worth if I got it paid out at my rate of pay upon leaving the public service. Does that make sense? Do you think that is correct?

If so, the best that can be said is that any decision will be based on probabilities, rather than firm knowledge.

Currently, I have no consumer debt but I owe approximately $8000 in student loans (interest is low and tied to prime; prime plus one percent, I think) and I have a mortgage for approximately $155,000 (but plan to sell my house in the next couple of months, with the intention of moving in with my boyfriend while he prepares his house for sale and, eventually, buying another house together with him).

My tentative plan for the money, if I took the cash out now, would be to put in an S&P 500 Index ETF or something similar to that. (Note: I have a defined benefit pension at work, and supplement it myself with investments in my RRSP and TFSA, which so far have been individual dividend-paying Canadian stocks such as Royal Bank, Enbridge, and Bell Canada. I would likely take this entire chunk to get exposure to the American market.)

In terms of predicting my future salary, (to assess what the severance amount would be worth upon resignation at some future point), the group Iím in just got a 12% raise (which happened basically the day after the day the severance pay was calculated) so if I were to resign right now, my severance pay would already have increased to close to $20,000. I would say itís likely that I would stay in the same professional group in the future and I still have quite a bit of room to climb in terms of pay before topping out in this group. (This is difficult to say, though. I only have one more raise at my current professional level before I hit the top of my pay scale but I would say I am more likely than not to make it to the next professional level before leaving the public service, and thereby see more significant raises, but this is far from being a given.)

Also, I would say itís likely that by the time Iím ready for early retirement and I resign, I would no longer have any contribution room in my RRSP so I wouldnít have the option of deferring income tax on the severance amount at that point. (One way to counter that is to retire early in the year and not make much income for the rest of the year.) This also means that if I take the pay out now, and put it in my RRSP, I will not have that contribution room for future savings.             

I have no idea if Iíve given too much or too little information in this post (if too little, feel free to ask questions) but I am hoping I have given the appropriate information for anyone who feels they can help me in my thought process. Am I considering the right factors? How do I go about figuring out what makes the most financial sense?

What I am leaning towards is taking approximately half the payment now and deferring the other half to when I leave the public service. That way, I could track the investments I make of the money I get cashed out and compare it to my pay out of the other half on resignation and actually know which of the two fared better in reality.

(Incidently, for Dan Ariely followers (Iíve watched some of his Coursera lectures) Ė the default choice is for the payment to be made upon leaving the public service. Employees have to take steps to get paid out now; if no action is taken, the payment is automatically deferred to when employees leave the public service. Despite that, the great majority of public servants whoíve been given this choice in the past couple of years have opted for a full, immediate pay out. I donít know if the fact that the majority is willing to make the choice that requires an extra step means that itís the clearly better choice for employees? Most people Iíve talked to seem interested in taking the money now to pay off existing debts, make renovations to their homes or otherwise spend the money on big expenses, including post-secondary education for their children.)

Finally, I do want to acknowledge explicitly that this is a good problem to have!

Kazimieras

  • Stubble
  • **
  • Posts: 167
  • Location: Ontario, Canada
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #1 on: July 08, 2013, 10:19:36 AM »
Oddly a nice situation to be in :) Also good call on trying to max out your RRSPs, even with a DB pension.

I am going to take some stabs in the dark to make up for some information that wasn't included. I am guessing your income is between 90-130k annually, based on the marginal rate you described. The good news is you're more or less at the top of the tax heap and don't have to worry about future earnings being taxed more heavily than they are now. So "when" to do it based on regular income taxation is off the table.

So the important questions - define retirement and what is the income you expect to have when you retire? What I mean by this is - you are thinking of retiring from the public service, at which point I assume you'd start collecting your pension. Once this occurs, will you be doing nothing, or do you intend on continuing to work? Also, look at how much you expect to be "earning" from the combination of your pension, RRSP withdrawals and other income sources and find that number. This tells you how much sense it makes to try to use an RRSP to shelter your money. Remember, RRSPs (similar to 401ks for the Americans in the audience) are for tax deferral, not avoidance. You will have to pay taxes on the money when it is counted as income and the question is at what marginal rate will it be taxed at. If you will be retiring and earning 80k a year once all incomes are added up, take out the cash now, take the tax hit and pay off the most expensive piece of debt first. If you think you'll be earning much less and your marginal rate will be much lower, then toss it in the RRSP and withdraw it then

<rant>People that are just starting work and earning 35k a year should not be contributing to their RRSP. Instead they should be putting money into a TFSA and investing it for retirement. Once they then hit a high marginal tax rate they should then shift that money into an RRSP, gaining a tax advantage. *sigh*</rant>

Lastly, and this is where a potential personal bias of mine gets in the way. I don't agree with the "severance" thing that you have, but you are entitled to it, so you should take it. I personally would not trust the government to leave this perk in place in future years. Some may say well they can't do that, but they did basically neuter it from what it once was, and if dollars are tight enough (and public support great enough), it will be clawed back. Remember public servants work for the public, and the public can be a mob at times.

chatsc

  • Stubble
  • **
  • Posts: 116
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #2 on: July 08, 2013, 10:50:37 AM »
my husb and I both work for the public service. i put mine towards our mort and he put his in RRSPs.  I think it is a win win situation.  I agree though the fact that leaving it in (and hoping it will be there come retirement time) seems the most risky.

plainjane

  • Handlebar Stache
  • *****
  • Posts: 1675
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #3 on: July 08, 2013, 11:57:48 AM »
"People that are just starting work and earning 35k a year should not be contributing to their RRSP. Instead they should be putting money into a TFSA and investing it for retirement. Once they then hit a high marginal tax rate they should then shift that money into an RRSP, gaining a tax advantage. *sigh*"

Note: apparently you don't need to claim your RRSP contribution the year you put it in.  So you _could_ put it in when you're making 35k, and then put it against your income when you're making 90k+.  cf: http://gailvazoxlade.com/blog/archives/4461

I haven't thought through whether it would make more sense to have it grow tax free in the tfsa & then move it over & take the tax advantage at a higher rate vs. putting it in to start and then taking the tax benefit later.  Mostly I hear about people going in the opposite direction as part of getting around the required withdrawals from rrsps late in life.

Dee

  • Pencil Stache
  • ****
  • Posts: 748
  • Location: Ottawa, Canada
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #4 on: July 08, 2013, 05:39:19 PM »
Oddly a nice situation to be in :) Also good call on trying to max out your RRSPs, even with a DB pension.

I am going to take some stabs in the dark to make up for some information that wasn't included. I am guessing your income is between 90-130k annually, based on the marginal rate you described. The good news is you're more or less at the top of the tax heap and don't have to worry about future earnings being taxed more heavily than they are now. So "when" to do it based on regular income taxation is off the table.

So the important questions - define retirement and what is the income you expect to have when you retire? What I mean by this is - you are thinking of retiring from the public service, at which point I assume you'd start collecting your pension. Once this occurs, will you be doing nothing, or do you intend on continuing to work? Also, look at how much you expect to be "earning" from the combination of your pension, RRSP withdrawals and other income sources and find that number. This tells you how much sense it makes to try to use an RRSP to shelter your money. Remember, RRSPs (similar to 401ks for the Americans in the audience) are for tax deferral, not avoidance. You will have to pay taxes on the money when it is counted as income and the question is at what marginal rate will it be taxed at. If you will be retiring and earning 80k a year once all incomes are added up, take out the cash now, take the tax hit and pay off the most expensive piece of debt first. If you think you'll be earning much less and your marginal rate will be much lower, then toss it in the RRSP and withdraw it then

<rant>People that are just starting work and earning 35k a year should not be contributing to their RRSP. Instead they should be putting money into a TFSA and investing it for retirement. Once they then hit a high marginal tax rate they should then shift that money into an RRSP, gaining a tax advantage. *sigh*</rant>

Lastly, and this is where a potential personal bias of mine gets in the way. I don't agree with the "severance" thing that you have, but you are entitled to it, so you should take it. I personally would not trust the government to leave this perk in place in future years. Some may say well they can't do that, but they did basically neuter it from what it once was, and if dollars are tight enough (and public support great enough), it will be clawed back. Remember public servants work for the public, and the public can be a mob at times.

Thanks for the response,  Kazimieras!

You filled in the income blank correctly with that range; I was towards the lower end of that range until a new collective agreement came into place and am now towards the upper end of that range.

My tentative plan for early retirement is basically that once my annual expenses are consistently lower than the annual income I would get from my pension, I will look to my other savings (by then, this should be a maxed out TFSA, maxed out RRSP and unregistered investments) with a view to having enough there to live off of for the period between that time and the time I can start collecting my pension.

My motto two years ago when I started trying to get there was "for 12 in 12"  -- as in save enough money to live off of for 12 years in the next 12 years. If successful, that would mean resigning from the public service at age 48 and living off my savings until age 60 (when I would start drawing my pension).

It's a nice slogan but I haven't really done enough calculations or planning to have any idea whether I am going to achieve it, whether it's the best approach in my circumstances, etc. Basically, it's still pretty sketchy, even after 2 years. Which really doesn't answer your question about how much I expect to be earning, I know.

With regard to the DB pension, if I figure retirement at age 48 but not starting to receive the pension until age 60, that would give me 18 years of service, so a pension of approximately 35k/yr (if based on an average salary of 140k for my five best-earning consecutive years). If I figure an extra two years of service (for a total of 20 years), then I get closer to 40k/yr and need to fund two fewer years from my own savings in the interim.

In this tentative scenario, I would then be drawing down on my RRSPs (and TFSAs) during the period of early retirement that would precede receiving a pension starting at age 60. So I would definitely be in a lower tax bracket.

Pretty much any approach I can think of that successfully results in my early retirement has me withdrawing RRSPs in a much lower income bracket than what I am earning now.

As for the argument in favour of taking the money now lest there be a claw back later due to public outcry.... I think this has been motivating many public servants to opt for immediate pay out. But I wonder if this is just a justification for wanting the money now and making it seem like the better choice? I honestly see it as a remote chance that the earned severance would be taken away for those who opted to wait it out rather than cash out immediately. What I see as slightly more likely in my situation is the possibility of my ending my career in the public service at a lower rate of pay... I can see it as a plausible scenario as I head toward FI to take a position with much less responsibility (and perhaps only on a part time basis) to wind down my working years instead of resigning directly from my current (high paying) position. So that's an argument in favour of taking the money now (given that the amount I would receive upon resignation would be linked to my salary at the time of resignation).

Financial Threedom

  • Guest
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #5 on: August 03, 2013, 03:49:21 PM »
Dee - I am also a Canadian federal public servant.  As always, there are some great points here.  It seems many of my co workers also decided to take the money now.  I would say this has been a mistake for many of them.  Even if the funds are transferred into an RRSP now, many could have waited to have a higher payout a few years down the road, thus a higher payout into your RRSP.  The only reason anyone should consider taking this now is if you are thinking of moving to a lower paying or part time position for when the withdraw is made.  However, even then I would check with my collective agreement to make this the payout is not made based on your highest salary earned. 

ghatko

  • 5 O'Clock Shadow
  • *
  • Posts: 53
  • Location: Gatineau, QC
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #6 on: August 07, 2013, 11:49:58 AM »
Dee - I am also a Canadian federal public servant.  As always, there are some great points here.  It seems many of my co workers also decided to take the money now.  I would say this has been a mistake for many of them.  Even if the funds are transferred into an RRSP now, many could have waited to have a higher payout a few years down the road, thus a higher payout into your RRSP.  The only reason anyone should consider taking this now is if you are thinking of moving to a lower paying or part time position for when the withdraw is made.  However, even then I would check with my collective agreement to make this the payout is not made based on your highest salary earned.

I personally think it's important to estimate how fast your salary is going to increase, and if you can beat that increase by investing the money in an RRSP, then the RRSP is the better option than waiting. That is the case for me, as I need to work on getting my French B/B/B levels before I can likely move up to a higher level position. In the meantime I am getting the standard increase of 1-2% (or whatever it is) per year. I can certainly beat that in my RRSP, so that was the decision that I made.

Catbert

  • Handlebar Stache
  • *****
  • Posts: 1720
  • Location: Southern California
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #7 on: August 07, 2013, 02:24:52 PM »
I would tend to leave it there for when you leave.  It seems that you have a good chance of getting raises/promotions that will exceed inflation so it could be a good choice.  I always try to go for diversity in my overall investments.  I assume that you are already contributing plenty to your retirement accounts in diversified stock funds.  Leaving it as severance pay just gives you a different way of getting earnings. 

Dee

  • Pencil Stache
  • ****
  • Posts: 748
  • Location: Ottawa, Canada
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #8 on: August 07, 2013, 06:14:49 PM »
Thanks -- those are all really good points for consideration. I especially like the point about diversification.

I am still leaning towards taking half now and half later, in part for the satisfaction of being able to know in the end which of the two fared better.

Dee

  • Pencil Stache
  • ****
  • Posts: 748
  • Location: Ottawa, Canada
Re: Severance pay - take pay-out now or pay on (early) retirement?
« Reply #9 on: August 13, 2013, 06:57:15 PM »
Well, I submitted my form today, requesting approximately half the severance pay I accrued now and half on leaving the public service. I took the maximum number of weeks I could now without being taxed at source (it had to be under $10k without prior CRA verification that there was contribution room). So I should get a tidy amount to throw in my RRSPs. As long as I track what investments I use it for, I'll be able to compare the value of that when I leave the public service to the value of the other half that I am going to receive based on whatever my rate of pay is when I leave. Time will tell which fares better.