How to be financially prepared when dealing with job loss
The potential for a job loss in today's economy is very real. That's why it's critical to be prepared — whether for a job loss or other potential crisis. Review these steps to learn how you can prepare prior to a job loss and what to do after losing a job.
Actions you can take now to prepare
1. Build your emergency fund cash reserve
An adequate cash reserve enables you to handle the unexpected, so you don't have to dip into your long-term investments. No matter what you currently have set aside, consider adding to it regularly. Every bit helps.
The rule of thumb:
Set aside enough money in an emergency fund to pay for three to six months of living expenses in case you lose a job or go through any other financial crisis.
If you are self-employed or face poor job prospects in case of a layoff, it would be better for that cash cushion to cover six to 12 months.
2. Consider whether a home equity line of credit (HELOC) is right for you
A home equity line of credit allows you to take a loan against the equity in your house and use the resulting funds for other purposes, including to establish an emergency cash reserve or to finance major expenses. Having this type of credit available can provide emergency funding if you lose your job. Plus, a HELOC offers these advantages:
- Unlike a term or closed-end loan, you only pay on the funds you use. For example, if you have a $50,000 HELOC and use $10,000, you only pay interest on the $10,000 balance, not the full line amount.
- You may have immediate access to cash. Most HELOCs offer personal checks so you can access your funds at any time.
- You may be able to hold off on using long-term investments for your short-term needs, which can help you avoid potential tax penalties in certain situations (for example, taking money out of an IRA or retirement plan before age 59 ½).
- You may be able to lower your cost of credit. Interest rates can be much lower through a HELOC than a credit card or personal loan.
- In some situations, you may be able to deduct the loan interest (check with your tax advisor).
Remember that a HELOC is still a loan that uses your home as collateral, and will need to be repaid with interest. Before applying for a HELOC, you should talk to your financial institution about interest rates and the term of the line of credit. Once the term expires, you will typically need to pay back all borrowed funds, and may not be able to gain an extension.
3. Look for riders on insurance policies
Some life and disability insurance policies offer riders for an additional cost, which waive premiums if you are unemployed. A waiver enables you to keep your important insurance protection in force, even when you may be unable to make premium payments. Check your policies to find out if a rider is already included. If not, discuss your options with your insurance professional.
What to do when you lose your job
There are a number of important decisions to make and steps to take right away. Start with these:
1. Scrutinize your monthly expenses and overall budget
Look at everything with a critical eye. Decide what's really necessary and what's discretionary. You may naturally spend less by not commuting (no cost for parking and gas) and eating fewer lunches out, but these budget cuts won't make up the income gap. Look for ways — large and small — to trim back expenses. For example, you may be able to reduce cable TV and internet services, switch to a less expensive grocery store and obtain better rates on your auto and homeowner's insurance coverage.
2. Apply for unemployment benefits
Unemployment benefits (also known as unemployment insurance) can help stretch out the time that your dollars will last, so apply right away. Benefits won't be paid until you start the ball rolling. In most states, you can apply at the local unemployment office or online, making it convenient and fast.
Unemployment benefits are generally available for up to 26 weeks, depending on the state you live in and other factors.
Remember that taking severance pay, temporary work or retirement payouts may disqualify you from receiving benefits, so make sure you carefully consider your options.
3. Prepare to pay taxes
You generally are required to pay taxes on unemployment benefits but money is not automatically withheld to cover them. Because of this, you'll need to set aside money to pay your taxes later or elect to have taxes withheld from your benefits if your state offers this option. Depending on your circumstances you may also need to make estimated quarterly tax payments. Talking to a financial advisor or tax professional can help you understand your tax obligations.
4. Secure health insurance
There are several options to evaluate before securing health insurance after you lose your job.
- If you currently have health insurance through your employer, a federal law known as "COBRA" entitles you to continue receiving that coverage at your own expense for up to 18 months at group rates upon termination of employment.
- Your employer or plan administrator is obligated to provide you with an election notice to enroll in COBRA coverage. This notice will inform you of the date your COBRA coverage is effective, when it ends and the cost. Group rates are available to COBRA participants, but they are more expensive than rates for active employees. Keep in mind that employers with less than 20 employees may not be required to offer COBRA. You can learn more about COBRA benefits at https://www.dol.gov/cobra.
- As a part of the Patient Protection and Affordable Care Act of 2010, you may qualify for health insurance through the Health Insurance Marketplaces, which are intended to provide affordable coverage. Depending on your income, you may qualify for a subsidy. Securing insurance through the Health Insurance Marketplaces may provide options that meet your health care needs better than COBRA, and it could potentially cost less. The open enrollment period for 2017 coverage runs November 1, 2016 through January 31, 2017. Visit HealthCare.gov for more information.
- If your spouse has a health plan, evaluate how it compares to continuing your health insurance under COBRA or enrolling through the Health Insurance Marketplaces. In some cases, it can be less expensive with equivalent or better benefits. If so, try to enroll. A job loss is typically a qualifying event for making benefit changes.
- And don't forget that if you have a Health Savings Account (HSA), you can continue to withdrawal the funds for eligible health care expenses.
5. Leave your retirement account alone if you can
If you can avoid cashing in your 401(k) or retirement plan balance, you'll be better off. The many drawbacks to taking a retirement plan distribution include:
- Distribution is subject to federal income tax and state tax may also apply.
- 10% IRS early distribution penalty if you are younger than 59½.
- The potentially large hidden cost of losing ongoing tax-deferred growth.
6. Talk with your advisor
At a time like this, meeting with an experienced financial professional can be especially helpful. Talk with your Ameriprise financial advisor to make sure you're making the best decisions to help you get through this difficult time.