Tuesday, March 4, 2008

More Thoughts on Ford Buyouts

I am continually asked two questions concerning the current round of Ford buyouts.
  • First, employees have an option to rollover their buyout into a 401(k)… it’s a great option worth investigating; and,
  • Second, the Big ($140,000) option requires relinquishing medical in retirement… it can be a good idea but be careful before you do this.
A lot of Ford workers have asked me about these issues, so here’s my take:

Rollover is a great option. “Rollover” means transferring your buyout amount directly to the 401(k) (TESPHE) plan (and, maybe, to an IRA after you leave Ford ). Here’s why you would want to do this. First, you save some big bucks in taxes. If you “roll” the buyout into the 401(k) you don’t pay any income taxes on these funds until you withdraw them from your account. This means all of your buyout money can be invested and will work for you until you need it… this makes a huge difference. For example, let’s say you have a $70,000 buyout. Assuming you work for the first-half of the year and then retire. Without getting into massive tax calculations, your buyout check, net of taxes would be $45,000. That means you have paid about $25,000 of taxes.

Say you’re 55 when you take this buyout. Well, you invest $45,000, and make 7% and pay taxes on the earnings at 19% (15% for Uncle Sugar and 4% for Auntie Jen (that’s Michigan slang for the State of Michigan), you’ll have about $66,200 when you reach age 62, and about $103,000 at age 70. This presumes, of course, that you don’t spend it on anything like cars, kids, vacations, vacations, broke relatives… or anything else. However, if you take the “magic rollover”, you’ll accumulate a lot more, since you aren’t paying the taxes up front. If you rolled the whole $70,000, you’d have $112,000 in your TESPHE or IRA at 62, and you have almost $196,000 in the TESPHE or IRA at age 70!

But, as I like to say, the “big print” gives and the “fine print” takes away. You DO have to pay tax on distributions from your TESPHE or IRA. But, here’s some good news: You will be retired when you take the TESPHE or IRA distributions, so you will probably be in a lower tax bracket than you are today. More “good news”, unless your pensions are over $84,480, you don’t EVER pay Michigan tax (if you’re over 59 ½). It’s also worth noting that there’s no FICA or Medicare taxes on amounts rolled over.

So, under our example, you were smart and rolled your buyout into the 401(k) or TESPHE. You let it grow to $196,000, and the proceeded to take about $1,500 a month for the next 20 years! (OK, about $1,300 a month after taxes). Even if you took the whole thing out in one year and paid tax all of the taxes (a strategy I advocate in the case of a terminal disease only), you’d still net about $130,000, considerably more than without the rollover.

So, the choice is simple: Option 1: Take your $70,000 buyout today, pay your taxes and have about $45,000 in hand; or, Option 2: Roll your $70,000 buyout (still have it available for an emergency) let it grow with no taxes until you take it out at age 70 and have about $1,300 a month additional income for 20 years?”

Rollovers are complicated beasts. Here’s a link to the IRS publication on IRAs. Here’s another link to the IRS publication on pension and 401(k) distributions. Also, go look at my previous blog on Ford buyouts to get my take on TEPSHE in general. My general “take” on rolling-over? It’s an idea worth looking at. If you would like our Firm to look-over your situation, call our office at 248-641-7400, or click HERE to set up an appointment.

Dump Your Medical? The second big question is whether to drop the retiree medical. There is a BIG ($140,000) payout for qualifying retirees who will sign off the medical plan in retirement. My take on dumping your medical has to do with a variety of factors, like whether your spouse has good coverage, and the security of future benefits. This decision is very personalized, so I’ll use some stories.

My buddy Tim came in the office on one of these rounds of buyouts. He has the choice of the BIG money with no medical or a lot less and medical for as long as Ford or he lives, whichever is shorter. His wife (who likes him and he likes her… important issues) is a teacher under the Michigan State Teacher’s system. She, like Tim, has over 30 years of service. Under the Michigan system, she’ll get retiree health care for her and her dependent. My take was relatively easy: we can take $140,000 from Ford and take our health insurance under the State, or we can pay $70,000 for double coverage. This one is pretty simple to me: her coverage is at least as safe as his, so provided they stay together,… go with hers and take the extra dough.

Suzie has a different scenario. She is 65 (and thus eligible for Medicare), healthy and single. She has no dependents. For her, the question is whether it’s better to have Ford as her secondary insurance over Medicare, or to go out and buy a ‘Medigap’ policy. Medigap policies provide coverage over and above Medicare, and come in a variety of flavors. The coverage ranges from A-L, with A being a catastrophic coverage, and L, being the full coverage of almost everything. Of course, you pay for all of this. For Suzie, the question was whether the extra money from Ford would be enough to cover the Medigap. She shopped for her Medigap, using the GUIDE from Medicare, which is pretty good. If her extra money pays for the Medigap, she wins. Her point was also she was betting on Ford always providing retiree health care, or even being around to pay it. She chose to take the Medigap and keep the extra money invested.

Ron is skilled trades and 49. He, like me, has a bunch of kids (4 is bunch to me). Ron’s an electrician with over 30 years. He can get an extra $70,000 by waiving health care coverage. He has bills and college tuition on the horizon. To him the extra money to waive health care benefits is a real boon and allows him to pay-off bills and set some money aside for college. However, I pointed-out that the cost of health insurance for a family of 6 (Ron’s wife does not get health insurance from her employer) is a whole lot of money, like about $800-900 a month. If Ron invested the entire extra money (which I’m skeptical about), after taxes on the buyout and assuming he made 5% after-tax, the extra dough would only pay health care for about 52 months, or a bit over 4 years. Barring Ford going out of business, I thought Ron should stick with the health care. If he does electrical on the outside as an independent businessman, he’ll save on the health care. If he gets another job, he can negotiate with his new employer.

Health care is important, especially if you have dependents. My take is to look carefully at your alternatives. If you’re covered elsewhere, like with a spouse or by the government, then the extra money looks good. If not, make sure you have alternative healthcare arranged, or be sure to set aside enough money to pay the cost of insurance yourself.

If you want help: If you want help analyzing a buyout, and live in Michigan, (or can work via e-mail and phone if you’re out of Michigan, unless you’re in Hawaii or San Diego, in which I’ll make an exception), feel free to CONTACT US.

Leon LaBrecque