Any smart financial moves while unemployed?

Q. - I’m out of a job, and it could be 6 to 9 months to find work. Any smart financial moves I should make?

A. - Predicting how long you’ll be unemployed is like guessing the Final Four or the college football champion. You might sense it will be a long time, but if you ask enough people who have gone through it, you realize it’s a “being in the right place and the right time” situation. Regardless, you need to prepare for the worst while hoping for the best outcome.

First, the standard advice is to cut all discretionary expenses ASAP. But if you sense this will be a long unemployment, I would go further. Refinance a car loan or sell one of your cars. Evaluate credit card debt and consider consolidating to a lower rate, paying off low balances to stop finance charges, or returning recent purchases, if possible. Next, evaluate all other expenses to find temporary savings. Lower the cell phone plan, turn the heat down, drop the gym membership, shop smarter for food, and cancel all streaming services (there are still free streaming channels and the library for entertainment). For federal student loans, seek a deferment. Put off any expense you can. From personal experience being unemployed, I wasn’t as aggressive about cutting expenses immediately, instead waiting 6 months before cutting some expenses, which was a bad decision. Had I known I wouldn’t have a paycheck for 14 months, I wouldn’t have waited.

Also, at the beginning, take stock of your emergency savings. You might have a few thousand dollars in a savings account or even 3 months of expenses set aside, but now is the time to consider other options. If you have a whole life insurance policy, is there a cash value you can borrow against? If you have a Roth account, how much have you contributed (only contributions can be withdrawn without penalty)? If you sold a car, how much would you get for it? What are your credit lines and interest rates? If you have a great credit score and a lot of home equity, can a home equity loan or line of credit be approved? You’re not going to tap any of these sources initially; you just need to understand what is available for use later.

While looking for work, do you already have a side hustle or could you quickly start one to ease the pressure on your finances? Finally, evaluate what you can receive in Unemployment Insurance from the state and how long it takes to claim it (generally, Unemployment Insurance can be claimed only after severance pay is depleted). What options are available for health insurance besides the COBRA option from your employer?

After all that initial work mentioned above, you have estimates of what has changed in your financial life. Maybe you could reduce expenses by $600 a month, but you still need $3,500 a month, which now includes a higher COBRA health insurance premium. If unemployment can provide $1,200 a month, how long can you spend $2,300 a month from savings without taking other drastic actions?

As the months go by, reassess your options. Maybe take a loan from Mom and Dad. Get an evening job delivering pizzas. Don’t consider the more drastic actions, such as tapping a retirement account or taking on debt, just yet. If you’re a homeowner, consider several options: taking in a renter, moving temporarily to your brother or sister’s house while you rent out yours, or selling. Then, when you’re down to about 2 months of savings, could you stretch it 4 to 6 months more by tapping a home equity loan? Additionally, evaluate mortgage forbearance or deferment options with your lender. And finally, the worst-case option: stop paying your mortgage. Before doing that, it’s best to understand the state laws governing foreclosure. If proceedings will be drawn out for a year, that is an option. However, there is the chance of losing the house and any equity you have in it, plus a credit score hit, so is that worth taking the chance vs. selling now? But under the circumstances, keeping a roof over your head, given the cost of other options - and if other options don’t exist - might be a consideration.

In summary, being out of work requires quick action to reduce expenses, and the development of plans should the job search extend beyond your resources. Again, prepare for the worst and hope for the best. As I said, during my 14-month unemployment, I didn’t react as quickly as I should have. I waited 6 months to refinance an auto loan and kept basic cable TV. With a sufficient emergency fund, I was less motivated to be aggressive about cutting expenses. By the 9th or 10th month, credit card debt started to increase because I felt I could go into debt by $500 to $1,000 a month and would have a job before I hit my credit limit. By the time I did get a job, I was $9,000 in debt at credit card interest rates. Had I ditched the cable TV, sold the 2nd paid-off car, and dropped one cell phone from the plan initially, I would have avoided most of that debt.

Now, back to the original question. Are there smart financial moves to make during this period of low or no income? Yes, but they’re mostly tax-related. The problem is that in March, you don’t know whether you’ll be out of work for the rest of the year or only for the next 3 months. So while it’s a good move to contribute the maximum to a Roth account when your tax rate is 0%, it’s difficult to find the money to do so (maybe you had the money in March but not by November). With a Roth, you can withdraw your contributions without penalty, so if you do contribute, you can get the contribution back later. On the other hand, if you finally get a job in March next year, you can contribute to last year’s IRA up until the tax-filing deadline.

The current U.S. tax code, besides taxing lower incomes less or not at all, provides some credits that can put money in your pocket, so to speak. There’s an Earned Income Tax Credit for those who earn income below a threshold, depending on filing status and the number of dependents. You may not have qualified while working, but being unemployed for even part of the year might lower your income enough to qualify (because the income you do have was earned). Then there’s the Saver’s Tax Credit for low- and moderate-income taxpayers. Here, the credit can be up to $1,000 for singles and $2,000 for couples, based on contributions and income. For example, you contributed to a retirement account from January to March, then lost your job for the rest of the year. You now qualify for the Saver’s Credit and will save on the taxable income earned from January through March. While it’s great to save on taxes, the problem for the unemployed is that you can’t reap the savings until early the following year, when taxes can be filed and a refund obtained, and by then you’re hopefully back at work.

Another tip to consider once you’re back to work (before the end of the calendar year): a Roth conversion. A Roth conversion is most tax-efficient when the investment declines in value or your income is low. For example, if you lose your job in March and find a new one in November, your income for the year might be 1/4 or 1/3 of normal, and you might be paying taxes at the 0% or 10% tax bracket. You could convert $50,000 to a Roth and be taxed at the 12% bracket, which is much lower than the 22% or 24% bracket you’d be in at your normal salary. Of course, the larger the amount converted, the more income tax you’ll owe in the following April for the previous year.

Finally, being unemployed is often a forcing function to manage your money better. While you spend all day looking for work, you’ll also spend more time on your finances because you have to. That habit can endure even after you’re back at work. Beyond the financial hit, there is lasting damage to your sense of security. You’ll get back on your feet and try to be better prepared if there is a next time. You may also come away with different perspectives and attitudes about what is important in life and change your career aspirations. Both are healthy mentally and financially. So while you take advantage of the tax code to lessen the financial impact, use what you learn about being more efficient with your money as a lifelong lesson in money management.