posted on January 11th 2017 in LA/OC CFP Team Posts with 0 Comments /

It can happen to anyone. Suddenly, you are between employers. And you don’t know how long it will take to land your next job.  

Especially in Orange County, where there is a thriving community of entrepreneurs, job change is common and is not always predictable.  

Even if you are voluntarily moving directly from one job to another, there are several important strategies to consider, and to apply to your unique situation. There’s a whole lot more at stake than just whether to rollover your 401(k) account!  

Before we begin, let me clarify something. If you will not be seeking a new full-time job, but instead are choosing to transition into retirement or semi-retirement, that is a different discussion. While some of the following may be applicable, I am assuming here that you will be pursuing a new opportunity for earned income to more than cover your spending.  And I also assume you may need to live off your assets during that search.  

Here’s where to begin.

  1. Look into unemployment benefits. If you were involuntarily terminated from your job, you may qualify for monthly unemployment benefits. You’re not “taking a handout”; you are collecting on insurance for which you and your employer have paid premiums every year. You’ve paid for it, so you might as well file the claim. You won’t qualify if you resigned, or if you were fired for “misconduct” (as California defines it). If a hearing is needed to resolve any employer dispute about your claim, there may be a delay in benefits, typically for just a month or two. Even for high-income people, the amount can be large enough to justify the modest time and energy needed to file a claim. It is not an emotionally uplifting process, but it’s your cash, so don’t walk away from it.
  2. Assess your cash position. Start thinking about where you’ll turn for cash to pay your monthly expenses. Look to checking and savings accounts, certainly. Also take a look at any brokerage accounts (that are not IRAs or other retirement plans).  Normally you may use your brokerage account to invest for long-term growth. It may be appropriate to sell stocks or other assets, even if this means triggering some capital gains tax, to free up spendable cash. At a minimum, consider moving a portion into short-term, high-quality bond funds so the value won’t fluctuate much in case you need to spend it.
  3. Decide how to use your 401(k) balance. You can’t borrow against your 401(k) after leaving the job. If you have a loan outstanding against your 401(k), determine whether the repayment terms change as a result of your employment change. Also be aware that if you roll the (remaining, non-borrowed) 401(k) balance to an IRA, typically the loan will be forgiven and treated as a taxable distribution to you.  

    That distribution is also subject to the 10% penalty for early withdrawal (and 2.5% California penalty), unless an exception applies. The most well-known exception is that you are over age 59½ at the time of the distribution. One interesting exception in the case of job change is that you are over age 55 at the time the job ended (not the time of distribution) and you take the distribution directly from the company plan (not through an IRA or other account). Another exception is helpful if you will now need to pay your own health insurance premiums; there is no 10% penalty on distributions used for that purpose. (Be sure to verify applicable law with your tax advisor, as these rules are subject to change.)

    If you made after-tax contributions to your 401(k) or similar plan at work, it may be possible to have those amounts distributed to you directly when you roll over the pre-tax portion to a rollover IRA account. This can be confusing, so be careful.  Special rules apply to Roth 401(k) contributions, which are also after-tax; I’m referring to non-Roth after-tax contributions.

    Generally speaking, it is convenient to roll your 401(k) balance into an IRA account that you can invest as you see fit over the years, adding additional 401(k)s after each job change. However, if you were 55 or older upon leaving the most recent job, consider leaving that balance in the 401(k) plan. This will allow you to take a distribution directly from the plan and spend it, subject to income taxes, but without the 10% penalty that would normally apply before age 59½. If your job search could potentially drag on long enough that you might need to tap into retirement accounts, having at least this account free from the 10% penalty would be a benefit. And if you have a very low-income year, there might be very little income tax to pay on the distribution. (There is more discussion of tax planning below.)
  4. Develop a strategy for other company benefits. Health Insurance can be continued under COBRA for 18 months, and longer in California (up to 36 months depending on your circumstances). While it is easy and convenient to continue your existing coverage, it may be expensive, especially if the employer had a very comprehensive plan and covered a large part of the cost while you were employed. You may want to consider switching, at least at the start of the next calendar year, to a less expensive plan. And current law provides a Premium Tax Credit the help cover the cost of plans purchased through Covered California, if your gross income is under stated levels (e.g., about $80,000 for a family of three in 2017). At present, you can buy health insurance from well-known programs like Blue Shield either directly (through an independent agent) or through Covered California, but only the latter puts you in a position to claim the Premium Tax Credit if your income turns out to be low enough. Here again, a CERTIFIED FINANCIAL PLANNER™ can be your ally, as this area is likely to continue undergoing significant changes.

    On a related topic, COBRA premiums do not count toward qualifying for the Premium Tax Credit. You can use your Health Savings Account to pay COBRA premiums, but no other medical premiums. You can use some of your IRA distribution to pay medical premiums without incurring the usual 10% penalty for early distributions. Bottom line: this whole interaction of premiums and taxes will benefit from careful planning.

    Stock options often expire 30 or 90 days after termination of employment, so make a plan right away! Also be aware that any modification of Incentive Stock Options can easily affect qualification for special tax treatment, so be very careful before asking for any accelerated vesting, extensions of time to exercise or other changes.

    Life and disability insurance may be convertible to an individual policy, sometimes at favorable group rates, and usually without medical underwriting (depending on the amount). If you need the coverage, you should look into the cost, which may be competitive. This is especially true if you have any health conditions that might make private insurance impossible to obtain. An easy rule of thumb: if you are taking any prescribed medications regularly, it may be cheaper to convert the group coverage than to qualify for individual coverage (though only an insurance agent can advise you on this).
  5. Be careful with debt. You probably don’t want to pay off any long-term debt (such as student loans, car loans or mortgages) just to be free of a monthly payment. While between jobs, it is probably better to preserve the cash you do have. If the debt bears a high interest rate, however, like many credit cards, paying it off can be a good move. It is important not to take on any new debt if at all possible, because interest compounds exponentially as time passes, making it very tough to recover if your job search is a long one. 

  6. Review your monthly spending. Even small cutbacks in discretionary spending can give you a very reassuring sense of control during this transition. It’s still important to have fun and relieve stress, so dine out if you like.  But instead of enjoying a full sit-down dinner, consider sharing appetizers with your sweetie during happy hour, and drop by an ice cream store or cupcake place on the way home. It’s important to continue exercising and getting out of the house, but if your gym membership suddenly seems expensive, ask whether they can suspend it for some time, while you lift weights at home (or with a buddy who has a weight machine), or try kayaking, or simply run or walk outside. Sites like meetup.com feature many free or nearly free activities like yoga in the park; scenic hikes you may not know about; and social gatherings like art nights, cooking classes, foreign language conversation groups, and other activities to keep you interacting with new people (who may hear of a job opportunity for you) and to keep you learning and creatively engaged (to relieve the lonely, tedious job hunt).

    If you decide you should trim expenses, which is prudent in most cases, it can be helpful to first review actual spending the last three months to get an overview.  Add things up under a few general headings (such as housing, cars, insurance, groceries and necessities, kids, business/job search, vacations, and so on). Most of us spend much more than we think, so this can be a sobering exercise. But don’t let this get you feeling down! The goal is to find a few things, large and small, that you can easily change. And even if you don’t make the changes now, you can look ahead to what you might do in six months or so. For example, you might choose to eat out less starting now, and to skip the movie theaters, but you don’t want to drop all the movie and sports channels from your TV package just yet. Focus right away on any larger items you won’t miss, and file your overview away so you can revisit it every couple of months.

    During a longer-term job search, which could consume most of your ready cash, or last longer than 9-12 months, it will be helpful to draw up a plan for more significant spending changes. These could include selling additional investments, selling a rental property, reducing aid to other family members, even swapping your expensive car for a nice-looking older model. It may be helpful to engage a CERTIFIED FINANCIAL PLANNER™to help you prioritize. You probably have more options than you imagine. They can also help you evaluate buying a franchise, starting your own business, or other ways to ease into paths other than full-time employment. 
  7. Look into tax saving opportunities. While tax strategies will depend to a great extent on your personal circumstances, and the tax law in effect at the time, I am listing here a few things to consider. I urge you to consult with your tax advisor and think of this as an “idea list,” not specific advice:
    • If you expect lower income next year (either because of a large cash payout when you were terminated, or anticipation of a long period with lower pay or no pay at all), you should consider maximizing tax writeoffs this year, and possibly shifting some income into next year.  

      One way to accomplish both objectives is to make a large payment of estimated income tax to the state of California before December 31. This is generally deductible in the current year, and any tax refund is taxable next year.  You can’t prepay an unreasonable amount, and if you are in the Alternative Minimum Tax it’s not deductible for you this year, so definitely check with your tax adviser on these points. But if you file your return promptly, you are only tying up the cash from December until your refund arrives, perhaps in May, and getting some tax reduction as a result.

      Another controllable deduction is your property taxes. You can prepay your April installment by December 31 to accelerate the deduction into this year.   Orange County makes it easy to pay online at the last minute. But watch out for the Alternative Minimum Tax, which could prevent any tax savings. And remember you are reducing next year’s deductions by the same amount (which is fine if you’ll be in the same tax bracket or a lower bracket next year, or won’t even have enough income to use all your deductions and exemptions).

      If you normally give a predictable amount to charity each year, and you have exceptionally high income this year that may not be repeated in the future, consider “pre-funding” your charitable contributions by donating 10 or 20 times your usual annual amount to a “donor-advised fund” like the Orange County Community Foundation or another similar organization. You deduct the contribution this year;check with your tax adviser for your specific maximum amount. The foundation will invest the funds, and in future years you can indicate the specific gift amounts you would like issued, and to which non-profit organizations. Strictly speaking, they control the gifts, not you, but they certainly have every incentive to agree with reasonable requests that meet their guidelines, and they are set up with this in mind.

      In 2015, with just these three ideas, I saved a professional acquaintance more than $100,000 on his taxes, when he confided to me during a casual 20-minute conversation that he was about to receive a seven-figure job-related settlement. We should be so lucky! But even if our amounts are 100 times smaller, this shows the value of brainstorming with a competent and experienced CERTIFIED FINANCIAL PLANNER™.
    • If you received 1099 income this year, talk to your tax advisor about whether or not to make a sizeable contribution to a tax-favored retirement plan. There are specific plans available to the self-employed, e.g. if you will receive a 1099 showing “miscellaneous non-employee compensation.”  Some of these must be set up before year-end, but some can be set up before April 15 of the following year. You can often shelter $18,000 to $40,000 or more in these plans, depending on your situation and assuming you won’t need the cash during your job transition.
    • If you made Roth conversions in the past, and more than five years have elapsed since then, you may be able to withdraw converted amounts without tax or penalty. Your tax advisor can tell you authoritatively whether this is an option available to you. Your CERTIFIED FINANCIAL PLANNER™ can review this with you, and can also show you the long-term benefits or drawbacks of using Roth withdrawals to fill in low-income years by supplementing cash flow without increasing your income taxes. Decisions like this, which have effects across many years or decades, are best made with long-term projections at hand, which your CERTIFIED FINANCIAL PLANNER™ can prepare for you.
    • If you have more deductions than income this year or next, look for ways to increase your taxable income, at least to the amount of your personal exemptions. Even if you are in the 10% or 15% bracket, you might consider triggering additional income, if it would otherwise be taxed at a noticeably higher bracket in a different year. In addition to strategies mentioned earlier (like taking a direct distribution of your 401(k) balance if you left the job after age 55), you could consider a Roth conversion. This is simply moving some money from your IRA, or IRA Rollover account, into a Roth IRA. This triggers tax, but no penalty, on the converted amount. Once in the Roth, there is no further tax on that money, or on the growth of the money, or on any future distributions from the Roth (assuming you wait until age 59 ½ and meet the other general rules). In essence, you are volunteering to pay tax early on part of your IRA, so you will never pay tax on that IRA again. This is especially attractive if you are in the zero percent or 10% federal brackets, but can make sense even in higher brackets. Do check with your CERTIFIED FINANCIAL PLANNER™ on this one, and as always, get confirmation of tax effects from your tax advisor. (We routinely examine this option, even for very wealthy retirees, who often enjoy several years of low taxable income before Social Security, pensions, and/or required minimum distributions from IRAs begin at age 70.)
    • If you expect higher income next year, delay your deductions, like charity, state income tax, and maybe retirement plan contributions. And accelerate income, to the extent possible.  

I hope this give you plenty of food for thought. A lot of this you can implement on your own, such as identifying ready cash and starting to look over your spending. At WorthPointe, we’ve not only helped hundreds of clients through job transitions, we’ve probably been through a few ourselves! If you have questions about financial planning, don’t hesitate to email us or call us at 800-620-4232.

about the author: WorthPointe Wealth Management

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