When a Client Leaves or Loses a Job

Clients may be out of a job, but that doesn’t mean they are out of financial options. These 10 planning considerations can help clients manage finances through periods of unemployment.

February 2012
by Michael Aloi/Journal of Accountancy

Given the continued weakness in the economy and an unemployment rate still above historic norms, now is a good time to review the financial planning issues clients face when they leave a job or are laid off. A CPA’s timely and proactive advice can have a lasting effect. Here are 10 planning considerations:

1. Maintaining Liquidity

Once clients are aware of an impending job change or separation, they must start thinking of cash needs and sources. I encourage my clients to file for unemployment insurance as soon as possible, given the lengthy processing time. In addition, opening a home equity line of credit can help with large, one-time expenses, and it may be advantageous to consolidate higher-interest credit card debt. Since rates are currently low, clients should explore whether refinancing a mortgage makes sense as well, assuming they can find a bank that will issue a loan. Clients who want to open a home equity loan or refinance (and will still have enough resources to make additional or higher payments) should do so while they are still employed, or they may have a hard time qualifying for a new loan.

2. Qualified Retirement Plans

Clients face several decisions on their 401(k) or other qualified retirement plans. Foremost, before leaving a company, employees should always review the plan for any outstanding loan balance and the plan’s options regarding the loan. Frequently, 401(k) plan loans must be paid off upon termination of employment. If liquidity is a concern, a better suggestion is to talk with the employer to see if it is possible to leave the loan in place and pay it back over time. I’ve seen some employers work with their employees on this.

If a client needs money from a 401(k) after leaving the company permanently, at least two options are available for those under the minimum retirement age of 59½ (Sec. 72(t)(2)). The “separation from service” distribution is available for those 55 and older. A second distribution option is the “substantially equal periodic payments” method. Both allow the client to immediately begin accessing 401(k) money without owing the 10 percent early withdrawal penalty, although, of course, income taxes still apply. A good planning tip is to encourage clients with one or more accounts they have maintained with previous employers to consolidate them into one with the current employer before leaving the company. That way, they can take advantage of the separation-from-service distribution, which is available only for the balance with the most recent employer. As always, if you are not also advising the client on taxes, it is important to encourage the client to consult a tax adviser regarding a rollover, contribution or distribution of plan assets.

3. IRA Transfers

Clients may also consider a rollover of a qualified plan to an individual retirement account (IRA) or a Roth IRA. A direct trustee-to-trustee transfer should avert withholding requirements. A number of pros and cons related to rollovers should be evaluated on a case-by-case basis. One non-tax-related consideration, for example, is the potential for reduced creditor protection, since Employee Retirement Income Security Act (ERISA) rules don’t apply to IRAs.

4. Net Unrealized Appreciation

Before rolling over or transferring a 401(k) to an IRA, clients and their CPAs should evaluate whether the net unrealized appreciation (NUA) rules apply. If clients own company stock in a 401(k), employee stock option plan (ESOP) or other qualified retirement plan, they are eligible for NUA tax treatment. Under these rules, the NUA in a distribution of employer securities that is attributable to employee contributions is not included in income at the time of distribution. Thus, the taxation of the NUA amount is deferred until the securities are sold, and the NUA is taxed as a capital gain -- not as ordinary income. The exclusion of NUA from income does not apply to rollovers; thus, NUA is not subject to the limitations on rollovers of nontaxable amounts.

This is a great area for CPAs to add value. Given that long-term capital gain rates are fixed until 2013 and the potential for increased income taxes still lingers in the future (not to mention, for high-income taxpayers, the 3.8 percent tax increase imposed on net investment income and the additional 0.9 percent Medicare tax set to take effect in 2013), NUA is an especially important tax strategy to consider now. There are disadvantages, of course, including the 10 percent early withdrawal penalty, if applicable, and income tax due on the basis of the stock distributed. In addition, the client loses the tax-deferred growth available in an IRA rollover, and the wisdom of continuing to hold the employer stock at all should be reviewed (see tip No. 8 below).

5. Restricted Stock

Clients who made a Sec. 83(b) election on restricted stock have already paid income taxes on stock they then forfeited upon leaving the employer that granted it. Commonly, those with enough influence at a job with a new company will negotiate a make-whole payment for any restricted stock they forfeited upon leaving their previous employment. However, most taxpayers are without such recourse except in rare circumstances. The Sec. 83(b) election is generally irrevocable but may be revoked with the consent of the IRS if the client can prove a “mistake of fact.” For details, see “Restricted Stock Awards and Taxes: What Employees and Employers Should Know,” and Rev. Proc. 2006–31.

This article has been excerpted from the Journal of Accountancy. View the full article here.

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