The pandemic has caused many to rethink their current work situation and reprioritize what matters most. Whatever the reason, make sure you understand all the financial implications.
Head of Wealth PlanningRBC Wealth Management–U.S.
The 4.3 million Americans who voluntarily left a job in Aug. 2021 was the highest on record in two decades, a trend in the job market dubbed “The Great Resignation.”
Workers voluntarily leaving their job is typically considered a sign of labor-market strength—people don’t quit unless they’re confident they can land another job fairly quickly. But the pandemic has caused many to rethink their current work situation and reprioritize what matters most.
Concerns about health, availability of child care and other factors, are driving some people to leave an employer with no real Plan B in mind. We’re also seeing pre-retirees accelerate their exit into retirement. Whatever the reason, before you quit, make sure you understand all the financial implications.
If you’re planning on taking significant unpaid time off between jobs or want to mitigate the risk of taking a new job, you’ll likely need a healthy emergency fund. Three to six months of your income is the usual recommendation to provide a financial cushion. But if you don’t have immediate plans to return to work you’ll likely want a plan to save even more. It’s important to think about liquidity to cover your typical monthly bills and to protect against the need to sell assets during a dip in the market. The amount in your emergency fund may also depend on your family situation. If you have a spouse who is at home with young children, you may want to increase that amount. A ready line of credit is another way to plan for a break in employment that may have an uncertain time frame or for those pre-retirees trying to bridge the income gap into retirement.
Leaving the security of a regular paycheck is scary regardless of your level of wealth. We also know our spending patterns change when we’re not working, or even in the new world of working remotely. If you plan to take an extended pause in your career, downsize your job or retire, think about how you’re going to replace that paycheck to fund your adjusted spending plan. For some, this might include a part-time job, gig work or other sources of income such as rental income. Restructuring your portfolio for more income is another approach. Annuities can play a vital role in creating a reliable income source. Having access to your retirement assets at age 59 ½ is also reassuring for those contemplating early retirement. Diversifying your income sources helps you feel less reliant on your current employment situation.
Do you have insurance coverage through your employer? Make use of your benefits before you quit. Go to the doctor, dentist and get an eye exam. This is especially important if your new employer has a waiting period before benefits begin.
You’ll want to explore your options for coverage in those gap months. For healthcare coverage, evaluate the cost of COBRA through your old employer or purchase coverage on your own. Keep in mind that the American Rescue Plan, signed into law in March 2021, expanded health insurance subsidies for most people purchasing their own coverage in the marketplace through 2022. If your spouse has benefits, it will make things a bit easier. But if you are the primary breadwinner or single, you won’t have that safety net. This may also impact your ability to contribute to a Health Savings Account.
Many employees have access to some level of life and disability insurance through their employers. You may want to explore supplemental coverage of your own and not through your employer. For pre-retirees, a policy review of your current coverage is important. There’s often an opportunity to reduce and repurpose insurance premiums for a greater purpose.
You should contemplate the opportunity cost of jumping ship by understanding what you’re giving up. Later in your career is typically the time where you can accelerate your wealth. You might be in your peak earning years, have big-ticket items paid for such as college, your primary residence is paid in full, and are able to sock away maximum levels in your employer’s retirement accounts. While non-employer retirement saving options are available, the limits are much lower. You also lose the lending feature of your employer retirement plans. And you may have unvested equity and 401(k) company contributions you’ll be walking away from.
These are also typically peak years for Social Security contributions. A gap in working years could affect your Social Security benefits. Your actual earnings are adjusted to account for changes in average wages since the year the earnings were received. Then, Social Security is calculated using average indexed monthly earnings during the 35 years in which you earned the most, so not working for a significant period could impact your benefits.
Employers help facilitate regular tax payments. Once unemployed, taxes become less automated and can add up quickly into a big tax bill. This is especially true if you transition to self-employment. Taxes, along with penalties, are also a big consideration when tapping into those qualified retirement accounts.
A drop in taxable income from an employment pause might be an opportunity to take advantage of a Roth conversion or partial conversion. A Roth conversion lets you move some or all of your retirement savings into a Roth IRA. You will owe income taxes, but ideally at a lower rate. Having Roth assets has the added benefit of diversifying your future income sources. Your adviser can help you run the numbers, navigate the rules and understand trade-offs.
As you exit your current employer, you’ll have a host of decisions to make including if you should roll over your retirement assets to a traditional IRA or even to your new employer’s plan. There are a number of considerations—from cost to convenience—that should be carefully evaluated. If you decide to roll over your assets, you should make sure you understand the options available to you, as well as the rollover process.
If you have company stock that has appreciated in your 401(k), there is a special tax rule call net unrealized appreciation (NUA) that provides a potential tax benefit. To do this, you take an in-kind or distribution of the employer’s stock as part of a lump-sum distribution. When you do this, you will pay taxes on the cost basis in the year of distribution; a 10% penalty may apply before age 59½.
Resigning or retiring from a job is a big decision with many financial factors at play, beyond just salary considerations. Reflecting on what you are resigning or retiring from and the related opportunity costs will help you decide what’s next. Having your wealth plan figured out ahead of time and stress testing for risks such as an extended time horizon without employment or a dip in the market will help bring clarity and confidence.
This article was originally published on MarketWatch.com
RBC Wealth Management does not provide tax or legal advice. All decisions regarding the tax or legal implications of your investments should be made in consultation with your independent tax or legal advisor.
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