10 Financial Tips to Prepare for a Layoff

By Dawn Handschuh, Personal Finance Writer   

Hundreds of thousands of U.S. workers have lost their jobs in the current recession, pushing the official national unemployment rate to over 8%. Four states now have unemployment rates over 10% — Michigan (11.6%), South Carolina (10.4%), Rhode Island (10.3%) and California (10.1%).

If you're worried you could be next, there are a number of financial steps you can take now — while you're still working — to proactively protect your financial best interests and improve the odds you'd be able to survive a layoff should it happen.

1. Bulk up your emergency fund. Forget the conventional advice that three to six months of living expenses is sufficient. In this job environment, where millions are competing for a dwindling number of new jobs, you could be out of work for a much longer period of time. If you're the sole breadwinner in your family, or single, there's even more reason to go above and beyond three to six months. Aim for nine months or even a year's worth of living expenses kept in a safe place, such as an FDIC-insured bank money account.
   
   You're not looking to invest this money, just keeping it safe from losses and easily accessible to you if you need to tap it. Online accounts such as ING Direct tend to pay higher rates than conventional brick-and-mortar banks. See Bankrate.com for up-to-date rate information.
   
2. Pay down high-interest credit card debt. While you're still working, you're in a better position to get serious about paying off that debt; once you're unemployed, continuing debt repayments will sap precious limited resources, and failing to take control of it will send you on a downward spiral of late payment fees and even higher interest rates. When paying off debt, start with the highest-interest debt you have and work down from there. Exception: See #4.
   
3. Put retirement funding on hold. Saving for your retirement is laudable under nearly any scenario, but when you lose your job, switch into survival mode. If a job layoff is a serious concern, stop contributing to your 401(k) plan and your IRA, particularly traditional IRAs, since traditional IRA contributions can't be accessed later without paying taxes and an additional 10% IRS tax penalty. (Though it should be a last resort, you can make penalty-free withdrawals from a Roth IRA.¹)
   
   If you ever borrowed from your 401(k), make sure to pay it back now if you fear a layoff. If you don't, the IRS will treat that loan as a taxable distribution, plus you'll be hit with a 10% tax penalty if you're younger than age 59 ½.
   
4. Stop mortgage prepayments. Stop making any mortgage prepayments you may have been making, for the same reason you should suspend retirement plan contributions. When your primary income source dries up (or threatens to), you must preserve as much cash as possible.
   
5. Scrutinize your spending. Don't wait until the worst-case scenario happens. Get a handle on what your typical spending patterns are, and pinpoint areas (cable TV, pricey cell phone plans, dining habits, etc.) where you can immediately cut back should you lose your job. Preparing in advance will make you feel more in control and allow you to act quickly during a time when others may act like deer caught in the headlights.
   
6. Consider applying for a home equity line of credit (HELOC). If your credit's good, consider this now while your income can help you qualify. A HELOC can provide you with a valuable source of ready cash while you're out of work, although it should only be tapped when it's absolutely needed.
   
7. Catch up on routine healthcare. Dental and vision coverage are often offered separately, for an additional premium, by many employers. If you're laid off, you can save a few bucks without sacrificing healthcare by opting only for medical coverage through COBRA and dropping the vision and dental care options.
   
   Catch up on your optometrist and/or dental visits now, while you're still working, so you won't miss the coverage after a layoff. With luck, you'll have found a new job by the time your next scheduled dental/optometrist visit rolls around.
   
   There's another reason to schedule any doctors' visits or medical procedures now, rather than later in the year. If you participate in your employer's Section 125 medical flexible spending account reimbursement plan, you'll be reimbursed up to the full amount you spent and designated at the start of the year, even if you're later terminated and haven't fully contributed those dollars.
   
   For example, say you opted at the start of the year to contribute $1,500 over the course of 2009 to your flexible savings account for out-of-pocket expenses. From January through April, you incurred $1,500 worth of reimbursable medical expenses, but you only contributed about $464 through your regular paycheck deductions. In May, you lose your job. You'll be fully reimbursed for all $1,500 worth of your eligible medical expenses, even though you didn't contribute that amount.²
   
8. Leverage paid time-off. Use any paid personal days you're entitled to if you need to, since employers don't typically reimburse laid-off workers for these. Preserve your vacation time, though, since unused vacation days are usually reimbursed, providing much-needed cash in the event of a termination.
   
9. Preserve your 401(k). Exhaust all other monetary resources while you're unemployed (temporary or part-time work, a HELOC, unemployment benefits, personal savings and your severance) before tapping your 401(k). You'll pay a heavy price if you touch it (with certain exceptions for "hardship" withdrawals) — withdrawals are considered taxable income, plus you'll be hit with a 10% IRS tax penalty for early withdrawal prior to age 59 ½. Depending on your tax bracket, if you're under 59 ½, you'll lose 35-45% of the withdrawal in taxes and penalties.³ What's more, it could be many years before you replenish your retirement kitty.
   
10. Postpone major expenditures. Now's not the time to proceed with your kitchen renovations or the purchase of a new car. Hoard your cash until you find a new job.

Layoffs can be stressful and turn your world upside down if you're not prepared, but with advance financial planning, you can take control of many of the unpredictable aspects of a job loss.

Also, be sure to read "Tips for Reducing Your Own Personal Budget Deficit" for more ways to pay off your debt.

Footnotes

¹ "Tapping Your IRA Penalty-Free." SmartMoney.com, January 30, 2008 h

² "Think You're About to Lose Your HR Job? Then Do This Before it Happens," SuccessinHR.com

³ "Hardship Withdrawals Give Access to Your 401k Savings, But at a Cost," 401kHelpCenter.com