Survival Plan Needed for When Paychecks Stop

The specter of rising unemployment raised its ugly head last month when the Labor Department announced that initial claims for unemployment insurance had hit a three-year high despite improvements elsewhere in the economy.

Economic growth was once a sure signal that more Americans would be collecting regular paychecks, but those days may be gone forever, financial pundits say. Internationalization, technological advances and a more thorough effort to maximize the bottom line are creating new and less permanent relationships between employers and employees.

“We are on the verge of a situation where everyone is their own universal subcontractor,” says Tim Kochis, chairman of the Certified Financial Planners Board of Standards and president of Kochis Fitz Tracy & Gorman, a San Francisco-based financial planning firm.

Workers are becoming more likely to sell their skills on a per-job basis to a variety of employers than to be lifetime employees of a particular company, adds Jack Kyser, chief economist at the Economic Development Corp. of Los Angeles County.

“We are moving out of the industrial Cold War economy into an international and world economy,” Kyser says. “That brings a whole lot of change to industry--and to people.”

Many people will miss the old security of working for a large company or institution. On the bright side, the shift allows some people more flexibility--”liberation” from the 9-to-5 workday, says Kochis, and it will make it easier to arrange leaves of absence and offbeat schedules. But it also requires a new type of financial planning.

Whether you call it a “catastrophe plan” or a “liberation plan,” you should have a formula for handling your finances in the event you’re cast adrift from the working world, says Margie Mullen, principal of Mullen Advisory, a Los Angeles-based financial planning firm.

How do you formulate such a plan?

The first step is to create a bare-bones budget, Mullen says. That requires taking a look at exactly how much you spend each month on essentials--keeping a roof over your head and food on the table, for example. Be prepared to lower your standard of living. While this budget should exclude entertainment expenditures and other frills, it should allow a little “slush” for rare opportunities, unexpected medical bills and emergencies, Mullen says.

You should probably review any quick income-producing and cost-cutting options you have. Could you make a dent in monthly payments if you traded in that fancy new car for a reliable used one? Can you put the gym membership on hold? Can you find a short-term renter for a room in your house or easily move to a cheaper apartment?

If you don’t have any savings, you should probably make some money-saving moves right now, at least until you have a financial cushion.

Your next step should be to consider a worst-case income scenario. If you were laid off, roughly how much would you collect in unemployment insurance? How much could you reasonably expect to earn from temporary, free-lance or independent contracting work? Do you have income from other sources, such as investments? Can you keep a major medical policy in force?

*

If your income is likely to fall short of necessary expenses, you need to consider the savings, investments and other assets you may have--and could cash in--in order to bridge the gap. Those assets could include savings and brokerage accounts, mutual fund investments, Treasury securities, equity in real estate and retirement plans.

Your final step is to formulate a plan to systematically liquidate those assets in the most cost-effective manner possible. Why? While certain assets may be readily available, they may also be relatively costly to tap, planners note. Ideally, you want to use them last and preferably not at all.

The most obvious example are funds invested in an employee retirement account, such as a 401(k) plan at work. Often, companies will give laid-off workers the option of taking their 401(k) funds with them or leaving them on deposit in the company plan. A natural inclination is to take the cash and use it to live on until you get a new job. But that’s usually a costly mistake.

If you fail to put the proceeds from your 401(k) distribution into an IRA account within 60 days, you face income taxes and penalties on the pre-retirement withdrawal. The federal tax penalty alone amounts to 10% of the distribution amount. Some states, including California, assess additional penalties. And the entire amount is subject to ordinary income taxes.

The bottom line: Between 30% and 50% of the amount you get is eaten up in taxes. If you have simple saving accounts and other so-called cash investments, it makes sense to tap those first. These investments are all easily converted into cash with little or no cost.

A second step would be to reduce the risk in your investment portfolio by selling some of the more volatile stocks, bonds or mutual funds when prices are high. Then reinvest the proceeds in shorter-term assets that can be sold without a substantial risk of principal loss, Mullen suggests.

If the money you’ve got saved and invested outside of retirement accounts is insufficient to tide you over, take a look at your borrowing power on credit cards, Mullen adds. While credit card borrowing is costly, it’s still less costly than draining your retirement account.

But remember you’re only borrowing for a short period--until you get a new job or a lucrative contract assignment--at which time you’d want to pay off the credit cards as quickly as possible, Mullen says.

Costly and onerous alternatives such as selling personal assets and depleting retirement savings should be considered only as a last resort, planners say.

*

Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or send a message to [email protected] on the Internet.