How to Advise the Suddenly Unemployed

Mapping out the issues with clients can help them avoid tax headaches and other problems.

By Michelle Rand
Michelle Rand
Michelle Rand

With the advent of an economic slowdown, job losses have become part of the scene, particularly in the technology industry. After enjoying an environment of healthy wage increases and promotions, unemployed clients may be facing a period of austerity.

Tech jobs are still available, but often these are with end-users (companies that adopt technology but are not technology companies). rather than creators (tech companies, like Apple and Microsoft). That means pay levels are lower and benefits are not as generous. In other industries, jobs are more numerous but may still force adjustments.

Changing or losing a job prompts a host of considerations:

  • Is there an acceleration of benefits, such as vesting?
  • Will there be severance pay, and if so, how does that compare to the household budget?
  • Is there a deferred-compensation balance, and what happens to it after termination?
  • Should the client roll over retirement funds to an IRA or a new employer?
  • How will stock options be handled? Restricted stock units?
  • Do terminated employees receive help from the company navigating benefits options?
  • What about replacing life, health and disability insurance?
  • Will the client need to use the funds you manage for her during this transition? Does the investment policy governing the management of the assets need revision?

While we don’t have space here to address all these considerations, we’ll discuss a few points on this roadmap, reflecting our experience recently.

Acceleration of vesting and severance pay can onerously affect tax payments

If your client worked, say, half a year, and then is forced to exercise options, and receive restricted stock units as well as severance pay, those funds can be enough to cause a major tax headache. The first partner you should bring into the analysis in this circumstance is the client’s accountant. A client should call their former employer’s human-resources department to learn of any options for delaying payments. If that’s impossible, sequestering money for quarterly estimated tax payments is a must. Keep in mind that if termination does not force the former employee to exercise his stock options, those expiration dates must be tracked to avoid abandoning their value through inattention.

Budgeting is a necessity now

The client may have been able to evade this process while employed. But without reliable income for some uncertain timeframe, it’s critical to assess what money can be used to cover expenses. Understanding how long benefits payments will last is critical. If the client cannot return to work quickly, the investment portfolio will be tapped. Evaluate the likelihood of this outcome and create liquidity if needed. Perhaps there is an opportunity to harvest losses to help offset a surprise tax liability.

Additional Reading: Retirement Tougher Mentally Than Financially, Advisors Agree

Furthermore, the client may become shy about risk. Explore this topic and, if necessary, revise the client’s asset mix and investment policy. Be sure to include the spouse in these discussions, unless there’s a very good reason not to; sometimes the spouse of a terminated employee will feel more risk-averse than the employee.

Rolling over – or not — should be thoroughly explored

Your client’s retirement-plan funds may be eligible for rollover to a new employer’s plan, or to an existing or new IRA, or it can remain in situ. Another option is to cash it out partially or in whole, but that will add to your client’s tax liability. (Note that if the balance is less than $5,000, the employer has the right to force a cash-out.)

Each alternative has its pros and cons, and some of these can be obscure.

For instance, if your client owns publicly traded company stock in his 401(k) — likely, since shares are often used to provide a company match — those shares can be eligible for net unrealized appreciation (NUA) treatment. This treatment — the difference in value between the average cost basis of shares of employer stock and the current market value of the shares — can offer considerable tax savings.

Another nuance applies to the ability to create a “back door” Roth IRA tax-free. This can be limited if a client has ever rolled 401(k) funds into an IRA. These are complex issues best considered in conjunction with an accountant.

More considerations

Rolling over employer-plan funds into an IRA also means the client must repay any outstanding loans against the plan. Further, the rollover triggers 59 ½ as the first moment the client can begin withdrawals without paying the early withdrawal 10% excise tax, unless the client chooses to use IRS Rule 72(t). Remaining in the employer plan, the client is able to withdraw at age 55 while escaping the excise tax under the IRS’s “rule of 55.”

On the other hand, an IRA offers a much wider variety of investment choices, and can actually be a more cost-effective choice, if low-fee funds can be utilized.

Rolling to a new employer’s plan is also a possibility, and if the client is in a position to pursue a back-door Roth, that can compel an employer-to-employer rollover. Of course, this strategy may require patience — you’ll have to wait to see if your client finds a new job.

If your client does pursue a rollover into an IRA that you will be managing, you are required to conform to the Department of Labor Fiduciary Rule, which entails issuing a disclosure of fees and other issues to your client.

An opportunity to shine

The mosaic of choices and strategies to consider on behalf of a suddenly unemployed client can be bewildering, but that’s where an advisor can demonstrate value. Proactively mapping the issues with your client will help him navigate this unfortunate circumstance with confidence, easing his transition to a new phase.

Michelle Rand is the founder and CEO of Cascade Investment Advisors, Inc., located in Oregon City, Oregon. The firm is a service-first, investment management firm.





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