Financial Planning

Surviving a layoff

Every year more than 10 million Americans lose their jobs.  2020 is much worse. According to a new McKinsey estimate 44 to 57 million workers will likely be subject to work slowdowns, furloughs and layoffs this year. The number who already applied for unemployment benefits skyrocketed to more than 16 million. The corona virus pandemic may put 1 in 10 Americans out of work.

Besides the obvious financial and emotional strain of losing a paycheck, there are also some additional pressures created by decisions that must be made regarding your employer-provided benefits. These choices are irreversible – once they are selected you are locked into the financial effects and tax consequences that might not be fully visible until several years later. But learning the basic tax and benefit planning strategies that apply to your specific situation will give you an advantage and help avoid costly mistakes.

Health coverage

Health coverage is usually the first and most important issue to be handled after a layoff. If you were covered by employer-provided coverage, a federal law known as ‘COBRA’ guarantees that you can keep your coverage for up to 18 months – but only applies if you work for a company with more than 20 employees. If this applies to you then you should learn the details of COBRA law now. The choices you make related to this benefit are irreversible. A common cause of error and confusion: your eligibility for other alternate health plans may depend on your eligibility for and whether you elected to apply for COBRA coverage. For example, if you were eligible for COBRA coverage and elected to not apply, then you may not be immediately eligible for coverage through your state insurance exchange.

If your company has fewer than 20 employees, then COBRA coverage is not available to you. Sometimes an employer may make an arrangement to continue to provide you with group health coverage after your employment is terminated. This is an insecure and dangerous situation. If COBRA coverage is not available to you under the terms of the federal law and the insurance company later learns of a claim on your policy, then the insurer may immediately terminate your insurance coverage and deny responsibility for paying any further claims. The insurer even has the legal right to rescind coverage retroactively back to your date of termination of employment. While most insurance companies do not strictly enforce these severe penalties, it just is not worth taking the risk with your health insurance.

If you are not sure if COBRA applies (for example, your company has had less than 20 employees in the past but has recently grown to more than 20 employees) you should put your request for COBRA coverage in writing to your employer and the insurance company. Usually they will err on the side of caution and offer you the COBRA coverage but this action will not be taken unless prompted by your formal request.

You should also be aware of your state’s unique coverage conversion rules. About half of the states provide for continuity of coverage regardless of COBRA or other provisions.

For most people, COBRA coverage and state-mandated plans are not the best health plan option because of their high cost. Chances are that your current group medical coverage contains many expensive features that you do not need. If you are usually a healthy person with small medical expenses then it might be best to switch to a lower cost short-term medical insurance plan. These plans cost less because they are not designed to pick up the cost of any expensive pre-existing conditions. They offer more liberal coverage than most group plans because there is no reason to manage claims as tightly as in an employer-sponsored health plan.

The most common sources of health coverage during periods of long term unemployment are Medicaid and the Health Insurance Marketplace. The Marketplace offers reduced premium coverage if your income falls within a stated range. It is important to consider the impact of severance pay and retirement plan withdrawals received during unemployment that affect the future cost of your health coverage.

A key determinant of successful navigation is having access to an experienced adviser in personal crisis management. The overload of information and misinformation on the web can be the downfall of your financial health.

For more information, ask for a copy of Freedom Benefits’ report “Understanding Your Health Plan Options”. Also ask for a free copy of our  COBRA plan detailed Q & As on these health plan issues when leaving an employer’s group health insurance plan.

The retirement plan

There is one universal rule when it comes to handling your retirement plan after a layoff: do not cash in your retirement plan directly even if you know that you must use the cash immediately. This rule applies regardless of whether your retirement plan is a self-directed 410(k) or a company-controlled pension plan. First roll it over into your own IRA account and then withdraw money from the IRA as you need it. This will lower your overall tax bill, make more cash available to you now and postpone the date that the tax you owe is actually due. The IRS makes many allowances for individuals to withdraw money from an IRA to pay for expenses while unemployed but these provisions are not available if you simply cash in your employer’s retirement account plan.

If you have outstanding loans on your 401(k) plan, the ideal situation is to refinance prior to losing your job. See the notes on “cash flow” section below.

To illustrate the point, consider the following simplified example of two people Jack and Sally, who each have a $10,000 401(k) plan. Jack cashes in his 401(k) plan immediately, while Sally does a rollover to an IRA and then withdraws the money after making a strategy with her financial adviser to take full advantage of the tax saving features of IRA withdrawals. Sally has $2,000 more cash available to her immediately, and ultimately (due to smart financial planning) owes $1500 less tax than Jack.

(chart omitted in republishing)

There are many firms that handle these retirement plan rollovers at little of no upfront cost to you. Some firms also offer tax planning that will allow you to minimize the tax bite while still using as much cash as you need to carry you until your next job. However, do not presume that your financial adviser is offering tax-wise advice unless you have a written agreement where the adviser acknowledges this responsibility. I have been called to rescue some individuals after they received bad advice – at least from a tax perspective – from their adviser who focuses on investments. It makes sense to use a firm that assigns a financial adviser you can rely on later for tax and other advice.

Stock options and company stock

Wildly fluctuating recent stock values have significantly affected many people – some favorably but many workers are affected unfavorably. When combined with a loss of employment in a weak economy, the effects can be devastating. Stock options are a great benefit in a rising stock market, but can be an unexpected bombshell in a market downturn. This is because income taxes on stock options are usually triggered before you actually receive any cash from them. If the stock price declines sharply before you sell, you still owe tax on the higher value. In many cases the tax you owe can be greater than the amount you receive from selling your stock or stock options.

To complicate matters even further, stock options are one of the primary triggers of the notorious “alternative minimum tax” (AMT) that catches many taxpayers by surprise. If you find yourself suddenly subject to the AMT, then this might have major implication in your taxes for at least several years into the future due to the “future credit” feature of the Alternative Minimum Tax if you received the type of options known as “incentive stock options”. This can be a more significant issue than many people realize. Many people who do not complete their financial planning prior to exercising a stock option wind up paying tens of thousands in taxes that might have been avoidable.

Many stock option plans have a provision that causes the options to be exercised at the termination of employment. This means that you have little control over the timing or financial terms of the transaction. In other cases, a terminated employee may exercise the options to raise cash in preparation for losing a salary. In either case, you must act quickly in order to protect yourself from market risk and adverse tax effects. The most successful financial planning strategies involve these steps: 1) timing the transactions to minimize tax consequences, 2) matching gains and losses for maximum tax efficiency, 3) AMT neutralization and 4) diversifying or insuring the investments to protect from market movements.

Cash flow

It always makes sense to take a conservative view of cash flow when making plans prior to a layoff. In this current crisis situation, I advise clients to plan for one the worst scenarios. If your credit cards, 401(k) loans and other personal debt can be refinanced at more favorable terms, now is the time to do it. There is no legal obligation to tell a lender that you suspect that you may be laid off in the future. But once the layoff happens it is nearly impossible to restructure your debt.

If you are not currently monitoring your cash flow on a monthly basis, this is probably an excellent time to start. Use a commercial software program like Quicken to help monitor personal accounting as well as improve personal financial planning.

A special note of caution if you have a 401(k) plan – if you terminate your 401(k) plan participation while you have an outstanding plan loan, the full amount of the loan immediately becomes taxable income and will probably be subject to additional penalty taxes as well. You could wind up owing the IRS almost half of the loan balance. You should make every effort to refinance the loan prior to terminating in the 401(k) plan.

Consider the tax effects

With an interruption in your income, your tax situation is likely to be entirely different this year. Low and moderate-income taxpayers are more likely to qualify for refundable tax credits in a year when there is a period of unemployment. This can ease the financial bite. Although you avoid adding additional expenses at this time, it makes sense to hire a tax adviser for a couple of hours to rework your tax situation. Even if you have not used an accountant or tax adviser in the past, this is a good time to consider finding a good one. Improve your chances of getting good advice by looking for an accountant with the credential letters “MT” (Masters of Taxation), indicating someone with training specifically in the field of tax planning (in contrast with tax return preparation, auditing or public accounting). It may cost a few hundred dollars for this professional help now but could easily wind up saving you thousands in the future.

This caution is included in the section above but is worth repeating:

Do not presume that the advice you are given is meant to be tax efficient unless your written agreement with the adviser acknowledges this responsibility.

If you are in a lower or moderate-income bracket, you might find that a layoff actually benefits you financially by placing you in position to receive one or more federal tax credits available. For example, suppose your salary is normally $37,000 but you only worked about half of this year. During that half year of employment you contributed $3,000 to your company 401(k) plan. Now you may qualify for a $1500 tax credit on your income taxes that might not have been available if you had worked the whole year. Since many different types of tax credits and allowable deductions are dependent on overall level of income, having a lower total income this year might have a significant tax-saving effect.

Other employee benefits

Group life insurance terminates with your employment. If your recent medical exams indicate any health risk factors (elevated cholesterol or high blood pressure) then it makes sense to consider converting your group term insurance plan to an individual insurance plan. Term life insurance plans are inexpensive but like all term insurance, the coverage will likely expire before you do. If you need permanent insurance then it makes sense to consider asking about a permanent plan at this point. Converting to permanent coverage might be better than converting to term insurance because the insurer is more likely to offer their best available rates. These “best rates’ are typically not offered to people simply converting from group term insurance to individual term insurance. See the “iquote” system at Freedom Benefits or a search of more than 400 lost cost term life insurance plans that offer personal enrollment support through OnlineAdviser service.

When converting any type of insurance plan from a group plan to an individual plan, you can use any qualified insurance agent of your choice. You are not obligated to use the agent who handled your company’s group insurance plan.

Dental plans and other ancillary health plan benefits are typically not included in COBRA coverage or other private conversion plans, so it makes sense to separately consider the impact of losing this coverage. If you expect to be working for another employer soon then it usually makes sense to “do without” for a few months. But if you will be without group benefits for many months or longer, then you can replace the group benefits with privately purchased benefit plans. Usually PPO discount plans are more cost effective than insurance plans for ancillary benefits like dental, Rx, vision and alternative care. A free prescription drug discount card is available at Freedom Benefits and a free 30 day trial of a dental / prescription / medical discount plan.

If you have a Medical Savings Account (MSA) or Health Savings Account (HSA) plan with our former employer, consider whether you may not make additional contributions or take qualified tax-free withdrawals while unemployed. The rules vary depending on individual circumstances. Most people can work around these tax issues to avoid unnecessary taxes and withdrawal penalties, but only if you are aware of them and plan accordingly. MSA account balances can be rolled over, tax-free, into a new account in a procedure similar to a retirement plan rollover. Make sure that you convert your Medical Savings Account to a Health Savings Account during the rollover to improve the benefits available. If you know that you will be paying for your own medical insurance for awhile while unemployed, you can save some taxes by making an extra tax-deductible deposit into your HSA now, and then paying for health insurance with the tax-free funds. This is one of the only practical ways for individuals who are not self-employed to deduct the cost of individual health insurance.

There may be good news with regard to other benefit plans like medical reimbursement plans, education assistance and dependent care assistance where you have a “use it or lose it” account balance. These are not required to terminate immediately when your employment ends, so you may be able to continue to draw on these for the remainder of the plan year. See your benefit plan description or speak with your company’s benefits personnel.

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