Oh no! Will being laid off scuttle retirement plans?

Kern Business Journal
December 2015

It’s a common problem prompting a common question: I have just been laid off. What should I do with my retirement money?

During the layoff frenzy of the Great Recession of 2009, I was answering this question nearly every day until economic recovery kicked in and people returned to work. But in recent months, many of my clients once again are struggling to keep their retirement plans on track as jobs are lost in Kern County’s oil patch.

With the price of oil tanking on the world market, blue collar and executive jobs are being cut from the work forces of international and independent producers and related service companies. Sadly this setback has hit close to home, with widespread layoffs reported in Kern County.

My initial advice to financial planning clients hit by these layoffs is: Don’t panic; don’t act hastily. A wrong move now can jeopardize your retirement security in the years ahead.

Withdrawing funds from tax-deferred savings plans, such as company-sponsored 401(k) plans, or borrowing against these funds are attractive options for meeting special needs when a regular paycheck is lost. But they should be “last resorts.”

According to Bankrate.com, 30 million Americans last year used their retirement savings to pay for an emergency. These withdrawals did permanent harm to people’s retirement plans.

Basically when it comes to tapping funds placed in a tax-deferred 401(k) retirement savings account, a person has two choices – borrowing or withdrawing. Both have few benefits and many risks.

Loans, which are available for limited purposes, are generally made at lower-than-commercial-market rates and can make funds available even to people with marginal credit scores. They also will not count against an individual’s credit score.

But borrowing denies the money the opportunity to compound over time and diminishes the overall value of the savings account. And failure to repay loans during a specified time frame (usually five years) will require the borrower to pay hefty taxes and penalties.

Simply withdrawing money from a 401(k) before a saver has reached 59 ½ years of age also requires the saver to pay taxes and penalties. The Internal Revenue Service reports that $5.7 billion in penalties were paid in 2011 on $57 billion prematurely withdrawn from tax-deferred retirement plans.

Before tapping these savings plans for emergency money, consider alternatives: obtain a home equity line of credit, personal loan, or loan from a family member or friend. Resist withdrawing funds or borrowing.

In the meantime, decide what to do with money in your company 401(k) plan. Unless you immediately get a new job, you basically have two options: Leave your money in the plan, or roll it over into an IRA.

Your ability to leave it in the old plan will depend on how much money you have saved. If your account has more than $1,000, but less than $5,000, your former employer can transfer the money into a Safe Harbor IRA of that company’s choice. If you have less than $1,000, you likely will be given a check for that amount, minus taxes.

The advantage of leaving the money in the former employer’s plan is convenience and credit protection. Federal law prohibits creditors from attaching 401(k) plans. However, you lose the ability to manage your own investments as you would with an IRA. Rolling your money into an IRA provides a wider range of investment options.

There is no single magic strategy to securing retirement plans and savings in a layoff. The key is taking thoughtful, careful steps:

Cash-flow projections – Develop a realistic picture of your finances. Include such income as severance and pension payouts, investment interest, real estate income, unemployment benefits, Social Security, etc. Develop a budget, which identifies current spending and potential cutbacks.

Look for work – Begin networking for another job immediately after being laid off. You may need to “reinvent” yourself, identifying skills that can be applied to other industries not affected by job cutbacks.

Being laid off does not kill your retirement plans. It just means you will need to be more determined to keep them on track.