Financial first aid can help families survive unexpected layoffs with the less trauma to their household budgets and investments.
First, stop the bleeding: Act quickly to reduce spending and resist the temptation to buy on credit, recommends the Financial Industry Regulatory Authority, which regulates financial advisors and works to educate investors.
Second, time for triage: Assess your situation to learn how much cash you have and how much you owe, said FINRA. This will help you calculate how long your savings will last.
Third, call for help: Make full use of any services to help dislocated workers. FINRA advises, “Make finding a new job a full-time job.”
At the same time, learn about your state’s unemployment insurance program to find out if you qualify. State unemployment benefits may be affected by other payments you receive from a company. “Knowing how much you can claim and how long you can expect to receive unemployment benefits will help you handle your finances,” FINRA said.
Take advantage of financial advice offered through a company or union. State and local employment agencies may also provide information, said FINRA. A credit counselor or financial professional can also help you develop a plan to cope while looking for a new job. With an emergency budget in place, families are in a better position to decide how to manage assets held in retirement plans or what to do with severance payments.
“Spend and invest lump sums wisely,” said FINRA, noting that employees are often tempted to spend severance benefits on something they’ve always wanted. “So do yourself a favor and wait,” said FINRA, “If you face a long unemployment period, these may be the only funds you will have to make ends meet.”
Many employees have savings accrued in retirement plans. The most common employer-sponsored retirement programs are known as 401(k) plans. They are also called defined contribution plans because they are funded by employees, who typically make regular contributions through payroll deductions. Employers can elect to match the contributions. The IRS gives 401(k) plans favorable tax treatment by allowing contributions to be made with pre-tax income and allowing the investments to grow tax free.
Layoffs do not affect employees’ 401(k) contributions, FINRA said. While employees are entitled to or “vested” in their own contributions, they might not be vested in employer matches since the employer decides how long someone must work before being vested in matching funds. An employee who is laid off or terminated can move or “rollover” their 401(k) savings to another plan and can continue to enjoy tax-deferred growth on the investments.
Employees may also have accrued benefits through cash balance plans, profit sharing plans and stock bonus plans. It’s important for employees to understand what benefits they own, when they can start receiving payments and the consequences of early withdrawal from the various plans.
Hardship withdrawals of 401(k) funds should be made as a last resort, because they will permanently reduce income received during retirement, said FINRA. If you cannot avoid withdrawing from retirement funds, FINRA advises tapping a Roth IRA first, because the tax consequences are milder than those for early withdrawals from traditional IRAs.
Workers also face significant financial risks from the loss of health insurance. A federal law known as COBRA can provide for continued health care coverage for up to 18 months.
Though households can take many steps to cope with a financial emergency, an ounce of prevention is worth a pound of cure. Advance planning is the best strategy for coping with a sudden job loss, said FINRA. The agency recommends a rainy day fund big enough to cover three to six months of living expenses. A household budget tracking income and expenses can help families to save at least 10 percent of their salary.
FINRA recommends current workers contribute to 401(k) plans as early and aggressively as possible and warns against taking out loans against the retirement plan. “Loans put a drag on your retirement savings by reducing the amounts invested on your behalf,” said FINRA. “In the event of a layoff, 401(k) rules generally require that employees pay back loans within 90 days of leaving.”