Dealing with company buyouts – Part 1: Severance

PART 1: Severance, deferred compensation, investments

Mergers and acquisitions are a common business strategy and often result in a realignment of talent among mid- and upper-tier executives. Frequently, many jobs are eliminated and severance packages are offered. If your company has recently been acquired or will merge with another company, it’s often wise to take immediate action to preserve the compensation you’ve earned and create a strategy to help strengthen your financial future.

Even if your position will likely be eliminated, there’s usually time to make key decisions. It can often take several weeks or months to develop and execute strategies for the new management structure and key jobs in the combined organization.

In our six-part series on the potential impact of a company buyout, we’ll discuss several important issues related to your finances that we think you should consider and potentially address.

In this article, we explore severance packages, deferred compensation and your investments.

Severance pay: Lump sum or serial payments

If you lose your job as the result of a corporate restructuring, there’s a chance you’ll be offered a severance package and need to make decisions relating to your stock grants and other compensation plans. Let’s explore some of the key items to consider.

Severance may be made in a one-time lump sum payment or follow a company’s regular payroll cycle of monthly, semi-monthly or bi-weekly checks. If you’re receiving a lump sum, one important question to answer is: What can be done to minimize the income tax impact of receiving this large cash payment?

While a lump-sum payment may feel like a “windfall,” it’s important to have a sound plan for this cash. You may be in a position to save and invest it for your future, or you may want to hold the payment in cash until your future cash flow needs are clearer. It can also be an opportunity to enhance your children’s college savings accounts, pay down debt or build a nice cash reserve as part of your investment and withdrawal strategy in retirement. If you don’t have a viable plan for this cash, the windfall could quickly disappear.

If you’re receiving serial payments, you’ll be able to budget your cash flow as you’ve done before. You still need a cash-flow plan for when these payments eventually run out. If you’re heading into retirement, your portfolio will likely become a primary source of income, and you need to know what accounts you’ll be taking money out of first, second, etc., along with which investments are best to liquidate. Or, if you land another job during the time you’re also receiving serial severance payments, you could use the severance checks to propel your financial plan forward—this might help you get to retirement earlier than planned.

Severance pay is subject to ordinary income tax, and you can’t defer any of this payment into your 401(k) or deferred compensation plans as it’s paid after your termination date.1 If your severance is paid in a lump sum, it can push you into a higher tax bracket. Even though income taxes will be withheld from your severance pay, it may not be enough to cover your personal tax liability. We believe this is a great time to work with a tax professional to determine if you need to make estimated tax payments. Don’t be caught off guard.

Deferred compensation

Funds held in a deferred compensation plan can be cashed out as part of the merger or acquisition. Don’t assume the payout elections you have on file with your deferred compensation plan administrator are correct, as changes in corporate control could lead to different payout provisions. Your entire deferred compensation plan balance might pay out in a lump sum, whether you remain at the new combined company or leave, resulting in a large tax bill. Since a lump sum will be taxed as ordinary income, approximately 40% or more of this money could be subject to taxes.

If you find your deferred compensation plan is going into payout mode, make sure you have a plan for this cash flow and the ensuing income tax bill. We’ve helped many clients use this accelerated payment to top off their children’s college accounts, fund charitable giving goals, eliminate their mortgage and build retirement savings accounts.

If you’re staying at the company, a new deferred compensation plan may work differently than the old plan, or there may not even be any deferred compensation program. This will likely mean drastic changes to your savings strategy and tax status, especially if you’ve been participating heavily in the past.

Investments

We believe a sound investment strategy is the cornerstone of building and preserving wealth. In our view, it should be designed to meet your specific cash flow needs, time horizon, growth requirements, tax objectives and risk tolerance.

If you’ve been a long-time employee of your company, your entire investment strategy might center around the available funds in your 401(k) and deferred compensation plans. Once employment ends, your investment strategy could transition into a portfolio 100% outside of the company’s offerings.

Having flexibility with your investment options is good but likely can be overwhelming during this difficult and emotionally challenging time of flux. You may suddenly transition to “withdrawal mode” after spending decades in “accumulation mode.” In our experience, this requires a different portfolio strategy, perhaps one with more bonds, cash or alternative investments. Or you may need to live off your investments for a short period of time until you secure another job. Determining how to adjust your investment mix, what account to draw from first and how to minimize the tax implications of each withdrawal is critical, in our opinion, during this transition period. Discuss your changing investment circumstances with your CI Wealth Advisor, whose aim is to help you manage potential near-term financial risks while also seeking longer-term opportunities.

We’re ready to support you

To make wise decisions when facing a corporate restructuring, we recommend understanding all the aspects of how this significant change may impact your finances now and in the future. Our team has the experience and expertise to develop your personal strategy, provide support as you try to make appropriate moves regarding your separation or transition package and, more importantly, help towards gaining clear insights into the potential impact on your overall financial well-being.

Other topics in this series:

• 401(k) and Supplemental 401(k)
• Stock options and restricted stock
• Pension plans
• Insurance planning
• Tax and estate planning

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