Laid Off With a Severance Package? Here’s How to Make a Plan

1. Get Organized!

Usually, there is a flurry of forms, booklets and deadlines that comes with a severance package. Gathering all the relevant information and staying organized is key. Make sure you have all the information for each type of company plan you own — deferred compensation, stock awards and options and the 401(k), for instance — this will help with planning. It’s best to check with the human resources department or the plan administrator for the rules on each plan.

2. Share the Information With Your Team.

Clue in your accountant and financial adviser of what’s happening. Your accountant and/or financial adviser can run tax projections to ensure you withhold enough in taxes. A financial adviser with expertise in corporate plans can help you navigate pension elections, deferred compensation choices and what do to with your stock options/restricted stock. Ideally, your accountant and financial adviser should have a call to discuss timing of income and taxes and share ideas.

3. Make a Plan for the Money.

First, ensure you have an emergency fund set up or use the severance pay to get one started. I usually recommend having enough to cover three to six months of personal bills in readily available cash or money markets. A little extra cash helps if you need it for additional income taxes.

If you already have an emergency fund and are comfortable with your cash flow or career prospects, then you’ll want to evaluate other ways to use the severance money, like topping off the 401(k) while you’re still eligible or maxing out a health savings account.

Older, more conservative workers may want to leave the severance pay in cash or pay down debt. Younger workers can consider keeping the money in cash then fund college savings plans when they secure their next job. Only a thorough review of your cash flow, goals and objectives can really determine the best use of the money.

4. Get the Timing Right.

It’s important to review the timing of severance pay with other company plans. Other company plans may pay out in the year you terminate employment. Deferred compensation plans typically distribute funds in the year of termination or the year of termination plus six months. That income plus the severance pay or a bonus you received already could put you in a higher tax bracket.

If that’s the case, ask about delaying the deferred compensation pay. Some clients will stretch the payments over several years to create a steady source of income. This can also spread the income tax liability over several years instead of bunching into one year.

Be careful, though: With deferred compensation, you are an unsecured creditor of the firm — if the company goes belly up, they can use those assets to satisfy creditors.

Also, think about the timing of exercising stock options. If the company stock price is currently down, perhaps staggering exercising options over multiple years makes sense. This way, you give the share price time to hopefully bounce back. Staggering the exercise of options also spreads the tax liability out over multiple years, which may prevent you from creeping up into the next tax bracket in one single year. Finally, with stock options, be aware of the expiration date: You don’t want to forfeit any options.

If you have pension, first be aware of any deadline to decide on your options. Some employers may offer a lump-sum buyout. You’ll want to review that offer with an experienced professional and consider the effect interest rates may have on your offer. It’s best to start with gathering the pension booklet, requesting a quote and discussing your choices with your team.

Finally, if you have more income coming in this year, then explore more advanced tax planning. If you are charitably inclined, this may be the year to accelerate contributions to a donor advised fund. Or if you have consulting or other self-employed income, then setting up your own employer retirement plan may make sense.

5. Evaluate Group Insurances.

Group insurances like life, health and disability are important for your personal financial planning. Employer group life and disability insurance may be portable — you can take it with you if you leave, but usually not at the group rate — it may cost more. Try paying for those insurances monthly instead of annually, until you can attain coverage through a new employer or purchase your own policy elsewhere. I usually recommend clients purchase their life and disability insurance privately so their coverage is not dependent on employment. In some cases, it is cheaper to purchase insurance outside of the group plan.

A severance may include provisions for health insurance. If not, COBRA or a private plan are options. It’s wise to price out a private plan to compare to the company’s plan. I have found the employer plan is not always the best and cheapest coverage.

Putting It All Together

Losing a job is a difficult time, and your head may be spinning in 10 different directions as you try to sort it all out. If you are offered a severance package, proceed carefully and thoughtfully.

Stay organized, gather up all the company booklets on each plan and discuss with your friends, family, colleagues, human resources and your financial team. You have one shot to get the most of out of a severance package, so you’ll want to get it right the first time.

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Michael Aloi (opens in new tab) is a Certified Financial Planner with 22 years of experience. For more information or a complimentary review of your pension options, please feel free to send him an email at maloi@sfr1.com

Investment advisory and financial planning services are offered through Summit Financial LLC, a SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Summit is not responsible for hyperlinks and any external referenced information found in this article.

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