Job market predictions for 2023 are looking a bit gloomy. The end of 2022 saw hiring freezes and layoffs at many large corporations, particularly in the tech sector, and that trend is continuing in 2023. Amazon alone has announced 18,000 layoffs in the early part of the year.
That has many workers nervous about their own job security. A layoff can have a significant impact on your financial health, but how you manage your money while you’re looking for a new position can make the difference between a relatively small financial tremble and a major earthquake.
In times of economic uncertainty, it's important to plan for the unexpected. Regardless of whether you lose your job or not, planning as if you will can set you up for financial success either way.
What should you do when the job market outlook is rocky?
The key to reacting to economic downturns and job losses properly is to understand why they happen and, conversely, why the economy did well before the downturn. Interest rates generally dropped for more than three decades before their recent increases. This made borrowing money relatively inexpensive. Companies took advantage of this by borrowing money in order to grow. Some companies, particularly in the technology industry, grew their footprint and their payroll without having to worry about showing a profit.
Now that interest rates are significantly higher than they have been in years, loans cost more to obtain. When borrowing money is more expensive, companies tend to look for ways to avoid having to borrow it. That often means cutting payroll. These contractions will be reflected in the company’s stock performance. Rising interest rates put pressure on the stock market.
This means it’s unlikely we will see the kinds of returns we became accustomed to over the last 15 years. Many investors became spoiled by incredibly high rates of return; if you’re basing your retirement planning on a 14% rate of return, it’s vital that you reset your expectations!
Preparing for a recession, regardless of whether your job is in jeopardy, is much like preparing for retirement. It’s important to get ready to maintain a lower income, whether you are no longer drawing a paycheck or because your investments are no longer enjoying the returns they used to. Ask yourself: If something goes wrong, am I prepared to handle it?
If you don’t already have an emergency fund, create one! Many high-income earners make the mistake of assuming their income will continue, or increase, their entire lives. Consider what might happen if you go from earning high six figures per year to losing six figures.
Can you absorb that loss without harming your future prosperity?
If not, then your emergency fund isn’t healthy enough, and you need to concentrate on bringing it up to par. Assuming income will remain healthy forever tends to make people less vigilant about creating /and maintaining emergency funds. Don’t fall into that trap!
What if you’ve already been laid off?
If you’ve been following sound financial practices, you’ve likely been contributing a healthy percentage of your paycheck to your company’s retirement plan. It may be tempting to raid your 401(k) in order to maintain your ability to pay expenses.
If at all possible, it’s particularly important to avoid doing this! There are a number of drawbacks to withdrawing funds from your 401(k) early.
● You pay taxes on withdrawals.
● By converting assets to cash, you lose the ability to realize future gains from those assets, which reduces your future financial health.
● If you’re less than 59 1/2 years old, you are likely to have to pay a 10% penalty for early 401(k) withdrawals.
● Even if you’re old enough not to have to pay that penalty, you are still withdrawing retirement funds earlier than planned.
The longer you can work before accessing your retirement funds, the more likely you’ll have a successful retirement because you will have fewer years to cover with them.
Some may assume they can borrow from their 401(k) rather than permanently withdrawing money from it. But there are several pitfalls to this idea as well. One study found that 86% of workers who change jobs amidst a 401(k) loan default on that loan. This makes sense, because generally 401(k) loans are repaid via your paycheck. Since you aren’t getting a paycheck anymore, it’s much more likely that you won’t make payments, especially if money is tight due to a job loss.
Even if you do keep up on your loan payments, you must use after-tax dollars to do so. This means you suffer from double taxation on that money: You paid income taxes on it before you used it to pay off the 401(k) loan, and you will pay income taxes on it again when you withdraw it from the 401(k) in retirement!
If you do default on a 401(k) loan, you will not only pay taxes on the outstanding balance because it will be considered income, but you will also pay that 10% penalty if you are under 59 1/2 years old.
Beyond those pitfalls, it’s increasingly unlikely you will even be allowed to borrow from your 401(k) if you have lost your job. Plans are more commonly refusing to grant loans to people who are no longer actively working at the company.
The economy is cyclical. This means good times will not last forever, and it’s very important to be prepared to weather the bad times. By planning ahead for economic difficulties, whether it’s a job loss or just that your investments aren’t performing as well as they had previously, you can structure your finances to absorb negative impacts before you have to resort to harming your financial future to keep your financial present afloat.
At Asset Preservation Wealth & Tax, we’re happiest when our clients are prepared for future economic difficulties; they’re more likely to have a successful retirement if they don’t have to raid their retirement accounts prematurely.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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