Surviving a Layoff

TN | April 10, 2005

Making smart financial choices when changing jobs

Each year more than 10 million Americans lose their jobs unexpectedly. 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 Insurance Coverage

Health coverage is usually the first issue to be addressed after a layoff. Employer provided group coverage typically ends on the last day of the month in which you employment ended. Health coverage for the next job typically starts on the first day of the month following 30 days of employment. As a result of this gap in group coverage it is necessary to make other arrangements to provide at least two months of other insurance. This section summarizes the key issues and considerations.

Short term medical insurance - a special type of health insurance is specifically designed to bridge the gap from one group health plan to the next that may range from one month to three years. This insurance is designed to be inexpensive, portable and easy to use. Most people qualify for this option but this type of insurance does not pay for the cost of treating for pre-existing medical conditions. Short term medical insurance is not useful in the event of pregnancy or serious long term medical issues like diabetes or heart disease. Those who have more predictable medical expenses like outpatient therapy or long term prescription expenses should consider this coverage because the savings in premium expense, in most cases, outweighs the out-of-pocket cost of routine medical care. A common mistake made by individuals shopping for health insurance is to say "If it doesn't cover (my specific medical expense) then it is not useful to me". Individual insurance is not an efficient way to pay for medical expenses you already have. During this period of unemployment, focus on finding insurance to cover unexpected medical risks, rather than known medical expenses.

The primary benefits of short term medical insurance are 1) portability anywhere in the United States, 2) ability to use any doctor or hospital, 3) liberal coverage of "ordinary and necessary medical expenses", 4) no referrals required, 5) premium rates about 40% lower than comparable long term insurance, 6) provides a "Certificate of Creditable Coverage" to ensure immediate coverage of pre-existing conditions under the next group health plan. 

Try to refill all long term drug prescriptions before the termination of your group coverage. Most prescription plans will refill your prescription with  a 90 day supply of medication if your order is filled through a mail-in pharmacy. Many people are surprised to learn that the cash price of many common drugs is not as much as you might expect. For example, a co-pay of $20 may be required for a common high blood pressure medication when covered under a group insurance plan, but the full cash price might be only $28 per month when not covered by an insurance plan.

If you have not done so already, complete your annual physical exam between the date of termination and the date your group health plan terminates. Make sure that your new insurance arrangements are already approved to avoid the possibility of issues with newly discovered pre-existing conditoins.

For more information see "Eligibility for Short Term Health Insurance" and "How Long Can I be Covered By Short Term Medical Insurance?". Policies are quoted and issued directly online. See www.short-term-medical-insurance.com for a listing of reputable insurance options.

COBRA - If you work for a company with more than 20 employees, a federal law known as COBRA guarantees the right to keep your medical insurance coverage, at your own expense, for up to 18 months after a layoff.  is usually the most expensive health insurance option available. For a limited time in 2009 the federal government will subsidize the cost of this insurance. Monthly premiums are typically more than $1000 per month for full family coverage so most people avoid this route. If you have large ongoing medical expenses of a significant pre-existing medical condition, then this may be the only logical choice. If this applies to you then you should be familiar with the details of COBRA law; the choices you make are irreversible. Eligibility for other health plans may depend on your eligibility for and elections made with regard to COBRA coverage. Although most people do not use COBRA, when changing employment it makes sense to understand the basics of this coverage in order to preserve your coverage rights and options.

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. More information on COBRA coverage is available at COBRAplan.com.

Individual Conversion Option - COBRA benefits are not available to the employees of smaller companies, but the same result may be available through a program referred to "individual conversion". In this case the insurance company allows members covered under a group plan to convert to an individual insurance plan without providing evidence of medical eligibility requirements. insurance are often required to offer . Sometimes an employer may make an arrangement to continue to provide you with group health coverage after your employment is terminated. This is dangerous for both the employer and the employee. If the insurer later finds that an employee has been terminated and COBRA coverage was not available under federal law then the insurer may immediately terminate your insurance coverage and deny responsibility for paying any further claims. The insurer may even have 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.

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. This is a bad time to learn that your health insurance may cost as much as your rent or mortgage. Chances are that your current group medical coverage contains many expensive features that you may not need now over the short term. If you are usually a healthy person with small medical expenses then it is usually best to switch to a short term health insurance plan (STM). 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. STM is typically priced at about 1/2 of the cost of COBRA coverage.

Health Savings Account - Withdrawals may be taken from a Health Savings Account without penalty to pay for health insurance during a period of unemployment.

Individual Retirement Account - Withdrawals may be taken from an IRA without penalty to pay for health insurance during a period of unemployment.

For more information, see the article title "Understanding Your Health Plan Choices"

The Retirement Plan

There is one universal rule when it comes to handling your retirement plan when leaving an employer: do not cash in your retirement plan directly from the employer's plan 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. Instead, 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. Whenever possible, defer withdrawals to the following tax year or take withdrawals over at least five years to avoid an early withdrawal penalty.

If you have outstanding loans on your 401(k) plan, the ideal situation is to pay these loans off through a refinance a home mortgage or other source prior to leaving your job. In many cases, it pays to act quickly to obtain a bank line of credit as soon as a layoff is expected even if the terms of the loan are not ideal. When a retirement plan with outstanding loans is terminated through a withdrawal or IRA rollover, the amount of the outstanding loans becomes taxable income. Consider this alternate strategy to reduce stress and save taxes: pay 401(k) loans with a new bank loan, roll the 401(k) into an IRA and then pay off the bank loan with IRA withdrawals over a period of at least five years saves taxes.

There are many firms that handle retirement plan rollovers at no charge to you. If your account is of a few firms also include tax planning to help minimize the tax bite while still using as much cash as you need to carry you until your next job.

Stock Options

Fluctuating stock options values in recent years have significantly affected many people - some favorably, some 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.

Managing Cash Flow

It always makes sense to take a conservative view of cash flow when making plans during to a layoff. If you expect to be out of work for a month or two, plan your spending as if you will be off for at least three or four months. If you know about an impending layoff in advance, then your credit cards, 401(k) loans and other personal debt might be refinanced of a layoff at more favorable terms to ease immediate cash flow. Make these arrangements as soon as possible while you are still working. There is no obligation to tell a prospective 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 "CPA" Certified Public Accountant or "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.

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.

Life Insurance

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 so it may makes more sense to apply for replacement coverage if you are in good health. Check the rate offered online by Guarantee Trust Life. This policy offers quick online enrollment up to $150,000 or $250,000 coverage that can be kept for a short or long time at your choice.

When converting any type of life insurance plan from a group plan to an individual insurance plan, you may want use an insurance agent to handle the transaction. You are not obligated to use the agent who handled your company's group insurance plan; every agent can be paid by the insurer to help you make this change.

Other Employee Benefits

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 for download at MedSave.com from your state listing page and an inexpensive comprehensive dental/prescription/medical discount plan is available at www.ehealthdiscountplan.com

If you have a Health Savings Account (HSA) plan with your 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. HSA account balances can be rolled over, tax-free, into a new account in a procedure similar to a retirement plan rollover. 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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