I’m looking for input to make sure I consider all relevant factors and approach the matter as rationally as possible in making a financial decision.
I’m 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 haven’t thought of in favour of cashing money out now and not putting it in an RRSP, I’m definitely open to considering that as well. It just hasn’t seemed advantageous based on what I’ve 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 I’m 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 it’s 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 it’s likely that by the time I’m ready for early retirement and I resign, I would no longer have any contribution room in my RRSP so I wouldn’t 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 I’ve 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 (I’ve watched some of his Coursera lectures) – 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 who’ve been given this choice in the past couple of years have opted for a full, immediate pay out. I don’t know if the fact that the majority is willing to make the choice that requires an extra step means that it’s the clearly better choice for employees? Most people I’ve 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!