Don't Let a Layoff Crush Your Nest Egg

You never know when you might lose your job, so make sure you know how to protect your retirement savings

By Ellen Hoffman

If you lose your job, your most immediate concern is finding another. But No. 2 on your list should be protecting your retirement savings, both in your 401(k) or other employer-related accounts as well as your own.

Even if you feel secure that you'll have your job for a while, you should still be thinking ahead. Challenger, Gray & Christmas, an outplacement company in Northbrook, Ill., recently reported that the average monthly rate of job cuts through November, 2001, is 163,208 -- more than three times the monthly average of 46,349 for every year since 1993. Until the sluggish economy recovers, the possibility of being laid off remains a hazard for thousands of Americans.

The other important reason for a rainy-day plan: The best strategy for protecting your savings is to start while you're still employed, experts say. "Look at the industry you're in. If layoffs are quite common, you should take two defensive steps to help you avoid dipping into retirement funds if you lose your job," says Stephen Craffen, a financial planner in Fair Lawn, N.J.

EMERGENCY FUNDS.

  First, "I recommend that people have at least six to nine months of reserves in a money market" or other liquid account, so that they can cover basic expenses such as the mortgage, utilities, and food, if necessary. Second, if you own your own home, he suggests you take out an equity line of credit and resolve that you will not tap that money for anything but a genuine emergency. It will be much easier to get the credit when you're employed, Craffen points out.

If you are laid off, your first steps depend on the type of retirement benefits that came with your job. If you have a traditional, or "defined-benefit," pension -- one that will provide regular payments after you reach a certain retirement age -- you need to get current information about the status of your future benefit. John Hotz, deputy director of the Pension Rights Center, a Washington-based advocacy group, says you should ask your employer for an "individual-benefits statement." The government requires employers to provide it free upon request at least once a year. The statement will tell you if your pension is vested and when you will be eligible to receive it.

You'll have to make sure you notify your former employer of any changes of address until you reach the age when you're eligible to collect your pension. The company has no obligation to search for you if it can't contact you at the address it has on file. For details, read this Labor Dept. publication on what to do if you are laid off.

ROLLOVER CONTROL.

  People whose retirement money is in a 401(k) or similar "defined-contribution" plan must decide whether to leave the assets in the company plan or withdraw them. Some employers may require you to withdraw the assets, and all employers have the right to require you to withdraw the money if the amount is less than $5,000.

Robert Walsh, a financial planner and CPA in Jersey City, N.J., says in most cases, you should roll over the assets from your 401(k) to an individual retirement account -- preferably a "conduit" IRA. Then he advises putting those assets into a 401(k) or the equivalent when you have a new employer. Keeping the withdrawal funds separate from those in an already existing IRA will facilitate the rollover into a 401(k). Also, the maximum contribution rules for IRAs don't apply when the money is being rolled over.

Rolling over the money will give you more access and control over it, because once you're off the payroll, you may encounter delays in accessing your account. When you do start working again and place your savings in the new employer's account, bear in mind that you may not have the same investment options as you did before. Also pay attention to how often you can make changes in your investment options.

REPAY THE LOAN.

  However, if you have an unpaid loan from your retirement account, you may want to rethink rolling over the money. If you can't pay off the loan and want to take the funds out of your 401(k), the Internal Revenue Service considers the unpaid loan amount to be an early distribution and will charge you income tax and a 10% penalty. You should try to repay the loan before moving the account from your current employer.

Retirement accounts that contain company stock also may present special issues. Walsh says you should never have more than 5% or 10% of your 401(k) in company stock. When you leave the company, you'll need to decide whether to keep some or all of the stock in the account when you roll the assets into a new IRA or 401(k) or withdraw the shares from your retirement account and pay taxes on it.

If you received company stock at a low price and it has appreciated a lot, you may benefit from having the shares distributed to you separately when you leave, instead of rolling them over into a new IRA or 401(k), he says. That's because you'll have to pay tax only on the value of the shares when they were put into the plan, rather than their value when you cash them out.

AVOIDING A PENALTY.

  Alternatively, he says, if you take the shares out of your plan and postpone selling them for at least a year and a day, you might benefit even more because they could be taxed as long-term capital gains, rather than at your income-tax rate. This is a complex decision, he warns, depending on the price at which you received the stock, its current value, and your own income-tax situation. To figure out what makes sense for you, he advises that you consult a tax expert.

To avoid having to pay the 10% penalty and income tax on any money that you withdraw personally for a rollover, you must have the money in the new account within 60 days of the date on the check from your previous employer. But if you have the check made out to you personally, your employer will withhold 20% for taxes.

Instead, Walsh suggests the most efficient process is to set up a new account. Again, a conduit IRA is preferable with a brokerage house or other financial-services company. And you should ask your plan administrator to write a check or send a wire transfer for the amount in your 401(k) directly to the new IRA custodian, incorporating the phrase "for the benefit of (your name)."

RAIDING THE STASH.

  If your income is below $100,000, you have the option of rolling the money into a Roth IRA so that you won't pay income tax on it when you withdraw it for retirement. However, this transaction will be treated as an early withdrawal from your retirement fund, and you have to pay income tax on the amount withdrawn, plus the 10% early withdrawal penalty. If your 401(k) has shrunk in the past year or two, this strategy could work for you in the long run. For help in sorting through your options, see this Fidelity Web site: www100.fidelity.com.

Most important of all, Craffen emphasizes, is to resist using the money in any retirement account for current expenses. He tells the story of a client, a bank executive, who lost his job while in his 40s and withdrew close to $90,000 from his IRA to pay living expenses before he got a new job. The next year the client had to pay about $30,000 in extra income taxes on the IRA withdrawal -- and to do this, once again, he tapped the IRA for an additional $10,000 to pay those taxes. This domino effect took a serious toll on his retirement savings.

It's often impossible to anticipate that you might be laid off or fired. But in this uncertain economy, hardly anyone is immune from the possibility, and there's no downside for preparing for the worst. If you do lose your job, some careful planning may help you avoid ruining your retirement savings. And as long as you're working, knowing you're prepared will help you breathe easier.

Hoffman, author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam, writes Your Retirement, only for Business Week Online. You can contact her through her Web site, www.retirementcatchup.com

Edited by Patricia O'Connell

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