The perils of choosing a buyout

Q. I am trying to decide whether to accept a buyout offered by my employer. How can I tell whether this makes sense for me?
A. If you land another job before the buyout deadline -- a job you'd rather have anyway -- the buyout might be a great deal.
You might also grab it if you're likely to be let go anyway, especially if you'd get less in a layoff.
Of course, the outcomes aren't always this clear, so the buyout decision can be very tricky.
Usually, a buyout is offered only when a company is in trouble, and you might be happy to leave. But even a crummy job is better than no job.
Unless you're on the brink of a well-funded retirement anyway, look closely at your job prospects.
If you stay, will your job get better or worse? What are your chances of finding another job as good as or better than the one you leave?
Rights and benefits
Be sure not to overlook benefits such as health coverage, vacation policy and pension or 401(k). Traditional pensions, for example, are typically based on your years of participation and peak pay. Retiring early can freeze the pension at a lower level than it would be if you stuck around another 10 years.
And read the buyout agreement closely. Does it prohibit you from working for a competitor?
Next, look at the money. A relatively rich buyout, offering, say, a year's pay, may look like a better deal than it is.
Taxes probably would take a big chunk. In fact, the buyout may boost you to a higher tax bracket.
Unless you get a new job immediately, ordinary living expenses will chew away at the buyout.
Finally, consider that even big sums don't go as far as you might think.
Starting with a million
A couple of years ago, a well-paid friend of mine was offered a buyout providing more than a year's pay. In asking my view of his early-retirement plan, he told me the buyout and other savings he'd accumulated over 30 years would leave him with upwards of $1 million.
Well, I told him, $1 million may not be enough for a 55-year-old to retire.
Assuming a fairly rich annual investment return of 8 percent, the $1 million would produce $80,000 a year. After federal, state and local taxes, assume there'd be $60,000 left.
Because a 55-year-old could live 40 more years, some of the investment income should be reinvested to make up for inflation. Assuming inflation stayed at its long-term average of around 3 percent a year, my friend would have to add 3 percent a year to his $1 million to keep its value steady.
That comes to $30,000, leaving him with an after-tax, spendable income of only $30,000.
Lesser options
Of course, he might not make 8 percent a year. To be safe, he could put all the money into long-term certificates of deposit or U.S. Treasury bonds. But then he'd make only about 4 percent -- $40,000 a year.
He'd still have to reinvest $30,000 to offset inflation. So he'd have only $10,000 a year, less taxes.
Couldn't he spend some of the $1 million principal?
Yes, but that would gradually reduce his investment income, forcing him to make ever-larger withdrawals from principal.
Assuming an 8 percent return, 3 percent inflation and that you expect to live for 40 years, the $1 million could generate about $44,000 a year after taxes -- from investment earnings and dipping into principal. That $44,000 would rise with inflation, but after the 40 years, the entire principal would be wiped out.
At a 6 percent return, this approach would produce about $34,000 a year. And at 4 percent, just $26,000.
Before you take a buyout, do these calculations for yourself. I used the retirement planning calculator in Quicken software.
What happened to my friend?
He took the buyout and quickly found his income too skimpy. Now he spends lots of time on eBay, making ends meet by selling baseball cards he'd been collecting since the 1950s.
XJeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at brownj@phillynews.com.