With PSR going through the class one railroads, understand the impact on their taxes and your railroad retirement, when you take that separation allowance from the railroad.
Welcome everyone to the Highball Advisors railroad retirement whiteboard. My name is John McNamara with Highball Advisors, and today we're going to talk about when you leave the railroad, perhaps there's downsizing going on or other issues, PSR, that type of thing. So what's that impact when you get that severance or separation allowance from the railroad? So I'm going to walk through it and then I'll talk to you at the end about some strategies that we can look at to help alleviate the impact. So the railroad, they eliminate the position, and what they're going to do is say, "Okay, we're going to compensate you with a lump sum or amount of money. Thank you for your time that you served with us, but you're no longer required to work at the railroad." So they're going to compensate you as you depart.
So now you're the railroader, what do you do? You relinquish your job rights to the railroad. You're no longer employed by the railroad, so you don't have that right to a job anymore. And then in exchange, you're going to receive a compensation. And that compensation is usually a lump sum, or it will be a periodic payment, which might be a monthly payment, or it might be a quarterly payments, that type of thing. So that's what you will receive in return. You hand over your rights, in return they give you compensation. But there's impacts of those decisions, so you want to be thinking about that as you're going through this, and this is a difficult time for a lot of people. They spend a lot of time with the railroad and there's a lot of emotions going on.
So this will give you an idea on how to handle it. So if you get the lump sum, because you're like, "Just give me my money and leave me alone." Type thing. However, that could pump you up into a higher tax rate, so you want to look at that, see where you are on the tax scale and if you do get a large sum of money that might bump you up into the higher tax rate. So you want to be very concerned about that. And also, depending upon where you are with your emergency fund, you might want that steady balance of periodic payments until you find another position so that you might want stretch those payments out. Also, that compensation's still going to get taxed on your tier one and tier two, even though you're not in the railroad, tier two also, and the Medicare tax also.
So that's going to get taken out of that compensation. And finally, you've paid the tier one, tier two. This is kind of a whammy here, your tier two, you don't get any more credit months of service. So they've taken out that tier two and you've paid this on this large sum. However, your final day is the last month of credited railroad service, and we all know that in tier two, you want those months of service because that increases your railroad retirement income on the tier two. So that's a bit of a whammy, so you want to recognize that. So I hope you found this helpful, understand, stretch out those tax payments is what I recommend and those other issues you really have to be aware of, especially on that retirement income, that tier two.
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