Are You Financially Prepared for a Layoff?

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If you are one of the many people who fear losing your job because of the current recession or for some other reason, start getting your finances in order now.

Preparing in advance will reduce the disruption to your career and personal finances that are almost inevitable if you become unemployed. And even if you keep your job, you’ll be in a much stronger position financially and mentally because you took these steps. Incidentally, many of these suggestions are a good idea under any circumstance, not just the threat of imminent unemployment.
 
Prepare a survival budget. Set up a budget that assumes you will be unemployed for a period of six months. First estimate your income during unemployment, including unemployment compensation benefits and severance payments. Look carefully at your past expenses and classify them according to importance: expenses that must be paid (such as the mortgage or the rent); necessities that could be reduced somewhat in the event of dire financial straits (home maintenance); and discretionary expenses, such as clothing, vacations, and meals at restaurants.

If your expected income during unemployment won’t meet your expenses—and it probably won’t—plan how to close the gap. Any solution probably involves a combination of reducing your living expenses and finding other sources of income.
 
Reduce current spending in order to increase savings. The two best things that you can do to prepare for financial adversity go hand in hand: Reduce your current level of spending and increase your savings.

Setting aside some savings now may help you meet your living expenses later if you become unemployed. A financial cushion is the best way to soften the trauma of unemployment. It is bad enough that you may have to go through the job-hunting process. But it would be doubly unfortunate to have to worry about making ends meet. So take action now to increase your savings or begin a savings program. Putting one percent of your income (or whatever you can afford to set aside) into a readily accessible savings or money-market account is a good start.
 
Manage your debt. If you have outstanding debts, such as auto loans and credit cards, should you reduce them in anticipation of unemployment or concentrate on building up your savings?
 
In general, if you are concerned about losing your job, you should be careful not to fall behind in debt payments, but you’re better off putting extra money in savings rather than further reducing your debt.
 
Here’s why: If you do lose your job, you may have to dip into savings to meet living expenses. If you use your savings  to reduce your debts, then you don’t have the financial cushion. Paying down high-interest debt is a good idea under normal economic circumstances. Your financial uncertainty, however, requires that you establish a generous emergency fund rather than reduce your debts.
 
Adjust your tax withholding. If you are quite certain that you are going to be laid off, you might want to arrange to have less income tax withheld from your paycheck. If you increase the number of exemptions, your take-home pay will be larger. This will provide extra income to use when you are unemployed.

Don’t worry too much about the tax implications. Even though you decreased your tax withholdings while you were still employed, the taxes owed will probably balance out by the end of the year.
 
Defer large expenditures. Now is not the time to make any large purchases, such as a new car, flat-screen TV, or home improvements. Wait until you are confident that your job is not in jeopardy. Even then, you should be very  careful about making major financial commitments when the economy is on the rocks. It’s tempting, because car dealers and home improvement contractors tend to lower their prices when business is slow. People who are blessed with abundant cash reserves and certain future-income prospects may take advantage of these offers, but you would be better off deferring all major purchases until your job uncertainty is resolved.

Plan for continuing  insurance coverage. One of the worst things people can do during a period of financial adversity is to let their insurance coverage lapse.  We’ve all heard unfortunate stories of people who thought they couldn’t afford to continue their health-insurance coverage, only to find their finances wiped out by an uninsured illness or accident. Be sure to include a provision in your budget for paying insurance premiums.

Also, decide ahead of time how you are going to replace your employer-provided health and life insurance when it expires. Your company is probably required to allow you to continue your group health coverage for a period of time after termination, as long as you pay the premiums. Look into it, and make it a priority to keep your medical coverage.
 
Review your investments. If you are expecting to lose your job, you should review your investments.

First, determine how much of your invested funds can be readily converted into cash to meet living expenses if the need arises. At best, you won’t have to liquidate any retirement-account investments (IRAs, 401(k)s, 403(b)s, or the like), since doing so is likely to result in hefty taxes, and, if you’re under age 59½, penalties.

Second, decide if you want to sell some low-yield investments, which pay little or no dividends, such as many stocks. Reinvest the money into interest-earning securities like certificates of deposit (CDs) and money-market mutual funds, which will provide you with higher current income to help meet expenses when you are without a paycheck.

For example, it may not make sense to sell any stocks or stock mutual funds that will result in big capital gains taxes in order to buy interest-earning investments like bond mutual funds and U.S. Treasury securities, since the taxes you’ll have to pay will reduce the amount of money available for reinvestment.

Have a plan for your 401(k). If you have a retirement-savings plan with your employer, something like a 401(k), you should probably roll the money over to an IRA after you leave.

One advantage of any IRA account is that once a year, you can borrow from your IRA with no taxes or penalty as long as you replace the money within 60 days of receiving it. This could help tide you over, but taking a loan from an IRA should only be done if you’re confident you can pay it back within the 60-day period.