Ending an employment relationship through lay-off, restructuring, or position elimination is never easy. Here are 5 things you need to consider for getting your financial ‘house’ in order before you start your job search.
As with any life transition, once the shock subsides, you’ll have important financial decisions to make. You’re going to want to talk to an employment lawyer, a financial advisor and an accountant. While a lawyer will counsel you on how much severance is reasonable and can negotiate on your behalf, a financial advisor and an accountant will advise you on how to best take a severance package to minimize taxes, maintain proper medical, dental and life insurance coverage during your period of unemployment and manage your finances during your job transition. It’s not uncommon for financial advisors and accountants to work together on your behalf.
#1 Apply for Employment Insurance (EI) as soon as you stop working, or risk losing benefits
EI provides regular benefits if you lose your job through no fault of your own, and pays you a percentage of your previous income, up to a certain amount. You’ve been paying into it for years, so take advantage of it. EI likely won’t cover all your expenses, but it may help ease the burden as you look for a job.
Always apply for EI benefits as soon as you stop working, even if you have not yet received your Record of Employment (ROE). If you delay filing your claim for benefits for more than four weeks after your last day of work, you may forego your entitlement to benefits.
#2 Your severance is taxable. Seek financial advice so you don’t pay more tax than you need to
Generally, severance can be paid in different ways, including lump-sum payment, salary continuance over time and deferred payments that may be paid to you over several years. You may also be eligible to allocate a portion of your severance to a retiring allowance. Make sure you look at all your options and get expert advice.
Your severance benefit is taxable. How and when you take it can impact your marginal tax rate for any year you receive a payment. For example, taking a lump sum in one calendar year could bump you into the highest tax bracket but taking a payment that bridges two tax years can minimize the tax impact.
It’s essential to consider each option and the tax implications in light of your unique financial situation. It may warrant one or a combination of options. There are strategies you can employ to help maximize your benefit and reduce overall taxes. Be informed and make the most of the rules available to you.
Here are some of the strategies you should consider.
- Transferring all or part of a lump-sum payment to your registered retirement savings plan (RRSP) or registered pension plan (RPP). Assuming you have contribution room, you can ask your employer to transfer all or part of your benefit directly to your RRSP or RPP. This strategy shelters your severance from immediate tax. However, you’ll pay tax when you take it out of your RRSP or RPP when you are likely to be at a lower marginal tax rate.
If you were with your employer prior to 1996, you might also be able to transfer additional funds to your RRSP under retirement allowance rules.
- Spreading severance payments over multiple years
While it may be tempting to have cash in your bank account, this could push you into the highest tax bracket. You can ask your employer to spread your severance over two or more years. You pay income tax only on the income you make in a given year. In this case, spreading your severance over several years may lower the amount of income tax you owe each year. When considering this option, make sure to take into consideration the solvency of the organization. If the company ceases operation before your last payment is due, you may have trouble getting your money.
#3 Consider your pension plan options carefully as your decision is likely irreversible
When you leave your employer, your company pension plan administrator will send you a written summary outlining your pension plan options. You’ll be required to select one of the options by a specific deadline. Sometimes you may not have very much time to make this decision.
The options vary by employer and depend on if you are in a defined benefit (DB) or a defined contribution (DC) pension plan. The more common options include:
- Remaining in the pension plan
- Purchasing an annuity
- Transferring your pension value to a Locked-in Retirement Savings Plan (LRSP) or a Locked-in Retirement Account (LIRA)
- Transferring your pension to a new employer
There’s a lot that goes into making the right decision for your specific situation such as when you will retire, your age, how much money you’ll receive at retirement, what other assets you have to fund your retirement, and how your spouse and/or other dependents will be affected. These are just some of the issues you will need to discuss with a financial advisor to make the best decision for you and your family.
#4 Tap into your savings and investments, the most efficient and tax-effective way possible!
We’ve all heard the tried-and-true advice “save money for a rainy day.” If you’ve been fortunate enough to be able to do just that, now is the time to use it, but do it wisely.
You may have money tucked away in a multitude of accounts at different financial institutions: savings account(s), a tax-free savings account(s) (TFSA), registered retirement savings plan(s) (RRSP), non-registered investment account(s) just to name a few. Conventional wisdom would have you think - ok, start with taking money from your savings account or emergency fund, then the TFSA, then non-registered; however, your financial situation may be different and it may make more sense to withdraw funds in a different order. Get advice that takes into consideration short and long-term tax and financial planning implications.
#5 Live on a budget. It’s prudent especially when you don’t know how long your job search will take and what income you’ll be making in the future
First, you are going to get through this and will probably find a more rewarding job.
While you are searching, you want to make sure you are taking care of your financial health – specifically your spending behaviors and habits.
This is the time to review and adjust your budget in light of your new reality or create one if you don’t already have one. A budget is essentially a plan on where you will spend your money and whether you will have enough money for the things you need or want to do. Budgeting can be incredibly empowering in giving you a sense of control.
- Allows you to effectively track cash in (income) and cash out (expenses), as well as set appropriate spending limits,
- Assists you in managing your monthly bills and expenses, setting you up for success, which means living within your means, and,
- Helps you stay on track with savings needed to achieve the important things in the short and long-term.
While you may have adequate income to fund your current lifestyle, be prudent, and cut back on expenses. You don’t know how long your job search will take, and there is no point eating into the nest egg you have worked so hard to create. Once you are working again, you can resume many of your more discretionary expenses.
Parting ways with an employer can be an emotional time, and you’ll have many decisions to make. I’ve helped many clients make the most of their situation. This article covers general things you need to consider. If you have any questions or want to discuss your specific situation, please contact me at email@example.com or 416.414.6354.