Stretching Severance Pay

June 29th, 2009, by

Q: I was recently laid off and am trying to optimize my situation under the circumstances. I am an engineer and will be turning 50 in September. I am considering paying off the rest of my mortgage with part of my severance package. The remaining funds in possession will be around $30,000 in cash and $120,000 in an IRA. I will be receiving unemployment benefits starting in September, which should allow me not to touch the cash for at least eight months. Hopefully there will be a job for me by that time. Could you please comment on my plan and its potential drawbacks?

Anonymous, Minneapolis, MN

A: I’m so sorry you’ve lost your job. And I’m sure you know you are not alone. The unemployment rate continues to rise, increasing from 8.9% to 9% in the latest figures from the Bureau of Labor Statistics of the U.S. Department of Labor.

If you have enough from your severance to pay off the rest of your mortgage, that suggests you don’t have much of a mortgage left, which is great, especially when so many people who have lost their jobs also face losing their homes.

First, you can’t consider the $120,000 because you are only 50 years old. Touching that money before you are 551/2 means you will lose much of it to taxes and that nasty 10% penalty for early withdrawal. So, you can’t rely on being able to use those funds just yet.

That leaves the severance money to live off of until you find employment. I would hold up on paying off the mortgage for now. I’ve worked with a number of individuals in which it took more than a year for them to find employment once they were laid off. The number of long-term unemployed (those jobless for 27 weeks or more) increased to 3.9 million in May and has tripled since the start of the recession, according to the Labor Department.

So, right now, you should preserve as much cash as possible. With the severance, you have enough money to pay your expenses including your mortgage, which is a lot more than what most people have. If you pay off your mortgage, you would eliminate probably your largest expense, but a long-term stint of unemployment could wipe out your savings, leaving you to struggle. In most states, the weekly unemployment benefit is helpful but pitiful—in many cases, only about $300 a week.

The good thing is, if you do find a job quickly, you can still take the severance money and pay off the mortgage. In fact, once you’ve worked on the new job for awhile, I would go ahead and pay off the mortgage. Then, you need to really boost your retirement savings. You can do that with the money you used to pay toward the mortgage.

Last modified: April 26, 2011 at 10:59 am