Financial Planning Considerations after Job Loss

By Brian Ellenbecker

It’s normal to feel lost, overwhelmed, scared or uncertain at the prospect of losing your job. The coronavirus pandemic has made job loss a reality for a significant number of people.  It’s possible that the economic impact could be felt for many months to come, meaning additional jobs could be lost in the coming months.

The good news is that you can limit the negative financial impact that a job loss might have by being prepared.  Here are some of the top things you’ll want to keep in mind in case you lose your job—either temporarily or permanently:

SEVERANCE PAY

In certain situations, you may be entitled to additional compensation.  In some cases, severance pay may be offered.  The amount is usually based on your length of employment.  Severance pay is taxable as compensation, subject to Federal, state and payroll taxes.

Accrued vacation days-are also paid out.  Income from vacation payouts is also taxable as compensation income.

HEALTH INSURANCE

Health insurance is often a benefit of employment.  Losing your job could mean losing your health insurance.  Understanding the options available to you is important to ensure you continue to have appropriate health coverage.

Your three main options to obtain coverage are through COBRA continuation coverage, joining your spouse’s employer plan or obtaining coverage through the Marketplace.

COBRA allows you to continue to the same coverage you had through your employer, although you are now responsible for the entire cost.  COBRA lasts for 18 months for most individuals but can last for up to 36 months in certain circumstances.

If your spouse has a health plan that covers non-employee spouses, evaluate how coverage from that plan compares to either COBRA or a Marketplace plan.

Marketplace plans are immediately available if you have a qualifying event, which includes loss of employer health coverage.  You will have many choices.  Be sure to consider the total cost of the plan (don’t just focus on premiums or deductibles) and the providers that are available under each plan.  Some plans have very wide networks of providers while others don’t.  Make sure your preferred providers are included.  You can start shopping for plans at Healthcare.gov.

Medicare is available for individuals who are 65 or older.  See Medicare.gov for more information.

Medicaid is available for lower income individuals with financial need.  Criteria for qualifying for assistance varies by state.  Check your state’s Department of Health website for details on who qualifies.  For Wisconsin residents, that information can be found here:  https://www.dhs.wisconsin.gov/medicaid/index.htm

UNEMPLOYMENT BENEFITS

Unemployment income can help replace some of your lost income.

Fortunately, the CARES Act enhanced unemployment benefits for many people, including who is eligible for benefits and how much eligible individuals may receive.  Unemployment benefits are available to individuals who lost their job along with self-employed individuals and independent contractors.  Unemployment benefits are very complicated, and the rules vary by state.  Contact your state’s unemployment office to understand what benefits you may be entitled to.

RETIREMENT BENEFITS

Availability of defined contribution plans

Defined contribution savings plans are tax deferred retirement savings plans, like 401(k)s and 403(b)s.  Once your employment ends, you have access to these funds and can typically do one of the following:

• Take a withdrawal.  Withdrawals are subject to income taxes and an additional 10% penalty if under age 55.  This option should be the last resort and used only when there is a critical need for money.
• Leave the funds in the existing plan.  Most employer plans will allow you to keep the money in their plan if the balance is over $5,000.  This can be a good option if the plan costs are low, you need additional creditor protection beyond what’s offered in IRAs, or you need to access the funds between ages 55 and 59.5.
• Rollover the funds to an IRA. A tax-free rollover to an IRA can offer additional investment options, professional management of the funds, consolidation of retirement assets and more flexibility in income and distribution options.

This is just a brief overview of pros and cons of each option.  It’s important to contact the plan administrator to fully understand all of your distribution options and your financial planner to ensure you understand the benefits and risks of your various distribution options.

If you have an outstanding 401(k) loan, it will be considered a deemed distribution, subject to tax and early withdrawal penalties, if applicable, if the funds are not paid back.  You have until the next year’s tax filing deadline to pay back a loan before it is deemed to be a distribution.  Plan rules can vary, so it’s important to confirm the specifics of how loans are handled upon separation from service to avoid any unpleasant surprises come tax time.

Even if funds from these plans are available to you, only use them as a last resort.  These funds have been set aside to support your retirement lifestyle and it may be difficult to replenish the account later.  Spending the funds now could sidetrack your progress towards funding the retirement you desire.

Pension

Some employers offer pensions.  If your employer offered a pension and you are vested in the plan, contact the pension plan administrator for an estimate of benefits and a summary of your distribution options.  If you are old enough to start receiving payments, work with your financial planner to understand how that income stream fits in with your overall financial plan to ensure that you maximize the benefits available to you.

For younger employees who are vested, it’s important to keep good records on this plan.  If a lump sum distribution option that can be rolled over to an IRA is not offered, you will need to keep track of this benefit until you become eligible to receive a distribution from the plan.

Deferred Comp

Deferred compensation plans are non-qualified retirement savings plans that typically supplement qualified retirement plans.  Typically, the funds in these plans become available once employment ends.  Withdrawals are subject to income tax but are usually not subject to an early withdrawal penalty.  Distribution options vary by plan and can be rigid.  It’s important to contact the plan administrator to understand the options available in your plan.

EMPLOYER EQUITY AWARDS

If you were awarded non-qualified stock options, incentive stock options, restricted stock awards or any other equity-based compensation, it’s important to understand how the terms of those awards may change if you were to lose your job.

Typically, you will be able to keep any awards that were vested and lose any awards that were unvested.  However, it’s possible the employer would allow unvested awards to vest under special circumstances, such as layoffs due to COVID.

Pay attention to the expiration date of awards—especially options.  Oftentimes, once employment ends, the expiration date on options accelerates.  If your expiration date is moved up, you will need to plan for the added cash flows and any associated tax liability.  Discussing these items with your financial planner and tax advisor is important to ensure you optimize the amount you will receive.

Check your plan documents or contact a benefits expert at your company for additional information on vesting and expiration dates.

EXPLORE FINANCIAL PLANNING OPPORTUNITIES

One of the first things you should do when you lose your job is to update your financial plan.  Your planner can help you run different scenarios to understand how your job loss might impact your financial future.  They can also work with you to help minimize any problems that might come up and may even be able to find planning opportunities to take advantage of.

As part of the planning process, review your budget.  Losing a major source of income may require you to evaluate your expenses and identify items that could temporarily be reduced or eliminated.  Reigning in expenses may help you avoid depleting savings, investments or retirement accounts.

Debt Management

If you have debt, don’t be in a rush to pay it down until you secure another job.  Liquidity is usually a higher priority than debt reduction in the short term.

Another way to cut your expenses is to try negotiating with your creditors to lower interest rates on your credit cards, defer a payment or two on your car loan, or reduce your monthly mortgage payments temporarily. COVID relief legislation makes these options even more viable.  You'll have to admit that you're facing some financial difficulty due to your job loss, but if your credit is good, now's the time to make the calls--not when you fall behind in your payments.

If your job loss is something that you can see coming, consider refinancing your mortgage before that happens.  With mortgage rates at all-time low levels, a refinance could lower your monthly mortgage payment—perhaps substantially.  However, you will need to complete the refinance process while you are still working.  Refinancing after you lose your job will likely be much more difficult.

Tax Planning

Losing your job means losing a source of income.  Estimate your taxes for the year.  If you expect your income to be lower than in a typical year, you may have some tax planning opportunities.  If you have lower tax brackets available, consider realizing additional income to take advantage of the lower tax bracket.  It might be a good opportunity to do a Roth IRA Conversion, for example.  In exchange for paying tax on the conversion amount, your dollars will grow tax-free inside the Roth IRA.  Make sure you have funds available outside of your IRA to pay the resulting tax liability.

If you are a business owner, you may generate a net operating loss, which can be a valuable tax benefit either now or in the future.

FINDING A NEW JOB

This is the time to dig deep and pull out all the stops to try to make your job hunt as efficient as possible.  Update your resume and make sure your LinkedIn profile is current.  Reach out to your professional network to help you identify potential employers.  Consider hiring a head hunter to help in your search or contact a local career center.  If your career is part of an industry at risk or if prospects are dim, consider enrolling in a class to learn a new skill.  Doing so could make you a more attractive hire for potential employers.

Losing a job can present challenges, but proper planning can help you navigate a challenging situation and emerge with limited damage and still in good financial shape.