Job Dislocation: Managing the Financial Impact of Unexpected Job Loss
You may not be able to control if or when your company closes a plant or lays off workers—but you can plan ahead and take steps to manage the financial impact of those events.
This Alert contains tips on how to:
- Ask the right questions about your company's benefit plans;
- Plan ahead to cushion the blow of a potential job dislocation;
- Keep your finances on the right track in the event of unemployment; and
- Protect yourself when getting financial advice.
Understand Your Company's Benefits
The most obvious benefit you get from your company is the regular paycheck that you count on for doing your job. Another benefit that you probably use frequently is your health insurance.
Other company benefits, such as a 401(k) or pension plan, help you build retirement security over time. Your employer may offer a variety of retirement benefits, and it is up to you to take the initiative to understand them, sooner rather than later. Do not be shy about asking questions. Below is a brief description of commonly offered plans:
These plans usually provide a series of payments, also called a defined benefit, after you retire. The amount you receive is normally calculated based on a combination of salary, age and years of service. Pension plans that replace a good chunk of your before-retirement salary are becoming rare. Employees who leave a job before a certain age or specified years of service with the company may not receive anything. This may happen when they have not met the eligibility requirements to become entitled, or vested, in the plan benefits.
These plans are referred to as defined contribution plans because they allow you to contribute a portion of your salary to retirement savings, and receive certain tax benefits. When you participate, the taxable salary that your employer reports to the Internal Revenue Service (IRS) is reduced by the amount of that contribution. Income taxes on that money and any earnings are deferred, or postponed, until you withdraw from your account. Generally, if you withdraw before age 59 ½, you will pay a tax penalty. Some companies also offer a Roth feature to the 401(k) plan that allows you to contribute after-tax dollars—known as designated Roth contributions. You pay taxes on designated Roth contributions up front, but their earnings grow tax free. Earnings on the Roth contributions may be withdrawn after age 59 ½ so long as the withdrawal is made five years after the initial Roth contribution.
The maximum amount you can contribute to a 401(k) is set annually by the IRS. For 2012, the maximum contribution is $17,000. This amount will increase to $17,500 in 2013. If you are 50 or older, you can add another $5,500 in "catch up" contributions for a pre-tax total of $22,500. The "catch up" amount will not increase in 2013. If your company allows you to make both pre-tax and designated Roth contributions, you may determine how much you want to contribute to each. You must, however, count both contributions towards the annual limit.
A 401(k) plan may give you several investment choices. The company may also match some or all of your contributions on a pre-tax basis. You will owe tax on any pre-tax contributions and their earnings when you withdraw funds from the plan. The money that you have contributed to the 401(k) plan will not be affected by events impacting your employer because you are always entitled to or vested in your own contributions. Your employer will decide how long you must work before you vest in the matching contributions. You may move (rollover) your 401(k) savings when you leave an employer allowing continued deferral of the taxable portion of your account.
Cash Balance Plans:
These plans provide for a benefit that is stated in terms of an account balance. Each employee has an account to which the employer contributes a specified dollar amount every year. The funds in the account earn interest at a guaranteed rate that is independent of the actual investment performance of the plan. Generally, you can take an annuity or a lump sum.
Employee Profit Sharing Plans:
The company contributes a certain amount of its annual profits to participating employees. Each worker's account is credited with its share of the contributed profits. The amount contributed often ebbs and flows with a company's financial performance.
Employee Stock Bonus Plans:
The company contributes a certain number of shares of its own stock to its employees. As with profit sharing plans, the amount of shares received tends to fluctuate according to the company's financial performance.
Ask the following questions to understand what you get:
- What are the terms of the plans that cover me? Ask for the summary plan description (SPD), the document that contains a complete description of the benefits owed to you and how they are calculated. Your company's human resources department, the plan trustee or administrator, or your labor union should have a copy of this document.
- When do I vest and how much is my benefit? The plan administrator or the company's human resources department should tell you exactly how long you must work before you become entitled to or vested in your benefits and how much those benefits will be. Understand how the benefit is calculated so you can double check that the amount reported to you is correct. Also check previous benefit statements that you have received along the way to ensure that the calculation is correct. Keep in mind that you are always vested in the amounts that you have contributed to a plan. Your employer, however, may require employees to work for a designated period to vest in the amounts contributed by the company.
- When can I start getting payments? You need to know when you can start receiving your benefits so you can plan accordingly. It is possible that you may not have a right to receive payments as quickly as you would expect even if you retire under normal circumstances. Some plans may provide for an early retirement option under certain circumstances if you have met the length of service requirement even if you do not meet the age requirement. This option usually results in a reduced benefit to the employee. Before you opt for payments, make sure that you understand what level of benefit—full or reduced—you are getting, the reason causing a benefit reduction, and how long you have to wait to get the full benefit provided by the plan.
Health Insurance: Learn about COBRA to Stay Healthy
One of the most significant risks of job dislocation is the loss of your health insurance. A federal law, known as COBRA, provides for continuation of health coverage up to 18 months after a job loss, under certain circumstances. Learn more about COBRA.
Plan Ahead: Start from Day One
Taking steps to create a financial safety net from the first day you begin working is the right thing to do. Here are some smart tips:
- Build an Emergency Fund: Save enough to completely cover 3-6 months of expenses. Keep it in a savings account or other safe place where you do not incur investment risk.
- Develop a Budget: Know how much comes in and what goes out. Set an amount to save from every paycheck. Try to save at least 10 percent of your salary. Make deposits to your savings account on a preset schedule. Over time, the amount saved will add up.
- Contribute to Your 401(k): Try to contribute at least the amount matched by the company. The match is additional money working for you. Start saving as soon as you are eligible to do so.
- Avoid Taking Out Loans Against Your 401(k). Loans put a drag on your retirement savings by reducing the amounts invested on your behalf. In the event of a layoff, 401(k) rules generally require that employees pay back loans within 90 days of leaving or face both income taxes and a hefty 10 percent penalty tax on the withdrawal. You should inquire whether your plan would allow for partial loan payments during the 90 days if you will not be able to pay the full amount in one payment.
- Use Credit Wisely: There are times when it makes sense to incur debt. Remember, however, that it needs to be part of your budget planning.
Job Dislocation: What to Do after Your Company Announces a Plant Closing or Layoffs
Whatever the reason for your job dislocation, you now face a period when handling your finances correctly will be critical to you and your family. These tips can help you take charge of your financial situation:
- Act Quickly to Reduce Spending. With less money coming in, you should take immediate action to reduce spending wherever possible. Resist the temptation to buy on credit.
- Assess Your Short-Term Situation: Figure out how much cash you have readily available or can get on short notice, how much you owe—mortgage, rent, credit cards, car loans—and the monthly payments associated with those and other debts. Establish how long you can make ends meet on the financial resources that you already have in hand.
- Ask About Dislocated Worker Services: Your employer may work with state and local officials to provide services such as job placement, retraining, or resume writing. Maximize your opportunity to get a new position as quickly as possible by taking advantage of these services—make finding a new job your full-time job. If you belong to a labor union, also ask your union what it can do to assist you.
- Inquire about Unemployment Insurance: A representative of the state's unemployment insurance office will likely be at your workplace to offer guidance and assistance in filling out the necessary applications. Ask the representative if you qualify and find out how the insurance may be affected if you get other payments from the company. Knowing how much you can claim and how long you can expect to receive unemployment benefits will help you handle your finances.
- When you file for unemployment insurance, state regulations generally require that you also register with the state’s employment service so you can start looking for a job immediately.
- Collecting unemployment benefits while working is illegal. You must report to your state’s unemployment office the date when you begin to work, either full time or part time. Do not wait until you get your first paycheck to notify the state.
- Take Advantage of Health Flexible Spending Accounts (FSA): If you have enrolled for a Health FSA and the coverage period has begun, consider spending the money while still employed for health items you'll need when unemployed. IRS rules allow you to withdraw the full amount you elected to contribute at any time during the coverage period. Check with the IRS for a list of medical expenses that qualify for tax-free use of your flex funds. You will need to document your expenses and confirm that they have not been paid or reimbursed under any other health plan.
- Get Financial Advice: Your company or union may offer guidance regarding the financial decisions you face. Your state or local employment agencies may also provide information. Ask questions as early as possible to help determine what is right for you. Consider working with a credit counselor or financial professional who can help you develop a plan to see you through your unemployment period and beyond. See below for tips to protect yourself when considering a financial professional.
Long-Term Job Dislocation: Smart Choices in Difficult Times
The prospect of an extended period of unemployment will require some difficult decisions that could affect your long-term financial health. Managing severance pay, choosing the form of payment from benefit plans, and preserving your retirement funds if you are still years away from retirement age are high in that list. Keep in mind the following tips when deciding what to do:
- Conserve Funds Meant for Your Retirement if You Can: Tap into your retirement funds to make ends meet only as a last resort. If you have a choice, choose to keep those funds invested and working for you until you actually retire.
- Understand the Tax Bite: Income taxes apply when you tap into retirement funds prior to age 59 ½. The plan administrator is required to withhold 20 percent of the amount you cash out to ensure that you will pay the taxes that apply. An additional 10 percent penalty tax may apply if you are under 59 ½ years of age. In order to avoid income tax and a tax penalty, you must roll over your funds to an Individual Retirement Account (IRA) or other qualified retirement plan within 60 days of receiving the retirement funds.
- Use Direct Rollovers to Avoid Potential Taxes: If you elect to roll over retirement funds, you may avoid tax complications and the risk that you will not complete a rollover within the required 60 days of receiving those funds. Choose a direct rollover by having the plan administrator transfer the rollover amount directly to an IRA or other qualified retirement plan.
- Spend and Invest Lump Sums Wisely: Receiving a lump sum may tempt you to spend it on that one thing you have been wanting all your life. Do yourself a favor and wait. If you face a long unemployment period, these may be the only funds you will have to make ends meet. Even if that is not the case, give yourself time. Consider short and long term needs before you decide what to do. If you decide to invest the lump sum, take your time to consider what you are going to invest in, when you are going to make the investment, and how much of the lump sum you want to invest in different types of investment such as stock, bonds, or non-financial assets.
- Tap Roth IRAs First: If you cannot avoid using your retirement funds, consider tapping a Roth Individual Retirement Account (IRA) first to help minimize taxes. You can withdraw contributions to a Roth IRA tax- and penalty-free at any time. Keep in mind that any earnings you take out will be taxed at your normal rate. They are also subject to a 10 percent penalty tax if you are under 59 ½ years of age. Consult a tax expert and IRS rules for details.
401(k) Hardship Withdrawals—A Choice of Last Resort
Your company's 401(k) plan may provide for hardship withdrawals. You need to be aware of the tax and long-term financial consequences before tapping into your retirement funds this way. Learn how 401(k) hardship withdrawals work.
Protect Yourself: Check Before Hiring an Investment Professional
The right investment professional can help you plan for your financial health from your first day of work. A professional can also work with you to make good choices during periods of job dislocation. Legitimate investment professionals must be properly licensed. To protect yourself when dealing with one:
Always Do a Background Check:
- For a broker or brokerage firm, or an investment advisory firm or representative, use FINRA BrokerCheck at www.finra.org/brokercheck or call toll-free (800) 289-9999.
- For an insurance agent, check with your state insurance department. You will find contact information through the National Association of Insurance Commissioners (NAIC) at www.naic.org or call toll-free (866) 470-NAIC.
- For brokers and advisers in any state, be sure to call your state securities regulator. Contact the North American Securities Administrators Association at www.nasaa.org or call (202) 737-0900 for the state's number.
Beware of Investments that Promise Too Much: The announcement of your plant's closing or mass layoff may have received national or local press coverage. If all of a sudden you find that you are receiving unsolicited offers for the investment of a lifetime, beware. If it sounds too good to be true, you know it probably is. Avoid becoming a victim by checking the credentials of the person offering these investment opportunities.
Protect Yourself: Avoid Job Search or Services Scams
There are many legitimate job services that could prove helpful in your search for your next position. Likewise, the vast majority of job ads that you will see are listed by real companies looking for good applicants. Keep in mind, however, that if the job service or ad sounds too good to be true, it probably is.
Always Check out Suspicious Job Services or Ads:
Beware of Job Search Ads that Promise Too Much: Resist the temptation to rely on job search ads or services that promise easy results. You should not have to pay to get a job, disclose personal or financial information in a job application, or use electronic money transfers via your bank or credit card accounts to do your job. These are all red flags that the job may involve illegal activity or someone may be trying to steal your identity.
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