Plan ahead

If you haven’t been laid off, it’s a good idea to plan ahead for that possibility. It’s hard to know how long you’ll be out of work, so to be on the safe side, prepare for at least six months of unemployment. You might find a job much sooner, but you don’t want to be forced to take the first opportunity that comes along, especially if it isn’t suitable.

Come up with a financial plan for unemployment, and design your plan with some flexibility to allow for adjustments if your situation changes. Circumstances can vary based on how long you’re out of work, and whether unanticipated expenses arise while you’re unemployed.

Prepare a survival budget

A big part of your unemployment plan is a survival budget. Start with a list of all your income and expenses. You might already have a budget that you can use as a base, but your survival budget should be a bare-bones version of your regular budget. Include only expenses that are necessary. The goal of your survival budget is to have a good idea of what income you need to actually survive.

Your plan also should include an emergency fund that’s equal to at least six months of living expenses from which you can draw to supplement other sources of income. If you haven’t set up an emergency fund, you may still have time to do so. You’ll be amazed how fast you can deplete your regular savings if your unemployment lasts more than a couple of weeks.

If you lose your job, find some income

Start by checking with your former employer. Are you eligible for severance pay? Whether it’s available depends on your employer’s policy, but if you’re offered severance pay, you might have the option of taking it in a lump sum or as a continuation of salary for a fixed period of time. Taking severance pay in a lump sum gives you control over your money, but you may lose some employee benefits such as group health insurance. If you take your severance as a continuation of salary, you may be able to keep your benefits, but you’ll be dependant on your former employer’s ability to make payments to you.

But don’t stop there. Check with your local unemployment office to find out if you’re eligible for unemployment benefits. You can receive at least 26 weeks of benefits (more in some cases). Generally, to qualify for unemployment benefits you must have been laid off. You may even qualify if you’ve been fired, so long as it’s not for misconduct. You probably won’t qualify if you quit your job, however.

Reduce your expenses

If you’re unemployed, you may find that your income won’t support your current expenses. Aside from reducing your debt by selling big-ticket items like your car or house, there are other things you can do to minimize your living expenses.

One of your first considerations should be to identify and discontinue discretionary expenses. Such items as magazine subscriptions, health club memberships, extra phone services, credit cards you don’t use that have an annual fee, dining out regularly, and extra pay services on your cable television are examples of some of the expenses you can trim from your budget. You also may have to put off that planned vacation until you’re back on your “working” feet.

Talk with your creditors

Another way to cut your expenses is to try negotiating with your creditors to lower interest rates on your credit cards, defer a payment or two on your car loan, or reduce your monthly payments temporarily. You also may be able to lower your home mortgage monthly payments by refinancing to a lower rate (if you can qualify in spite of your job loss), or by negotiating a longer repayment period. You’ll have to admit that you’re facing some financial difficulty due to your job loss, but if your credit is good, now’s the time to make the calls–not when you fall behind in your payments.

Along those same lines, check with your mortgage company or credit card companies or look at your billing statements to find out if you have credit insurance. Credit insurance will make your bill payments when you’re unemployed. However, you may have to wait a while before receiving benefits.

While technically not an expense, you can also decrease your spending by reducing your contributions to retirement or education funds. However, the less you contribute now, the less you’ll have for retirement or college, so this option should be a last resort. But you might be able to make up for the reduction in contributions by increasing payments to those funds when you’re back on your feet financially.

Increase your income

You’ve cut your expenses and spending as much as possible, but you still don’t have enough income. Here are some ideas that might help you meet your expenses while unemployed.

Consider a part-time or temporary job. This will provide another source of supplementary income while you search for your next full-time job. And your part-time job could turn out to be your next full-time job–or at least it might lead to another opportunity with another potential employer. Also, your spouse or partner may be able to get a job if he or she is not already working, or pick up more hours at a present job.

Another income-generating option is borrowing from the cash value of your life insurance policies. But you’ll be limited as to how much you can borrow by the amount of cash available and other policy restrictions. And you’ll be charged interest on the borrowed funds, so if you don’t repay the loan, it can reduce your death benefit or even cause the insurance to lapse.

If you’re really strapped

Your home is another source of savings you may be able to tap into. If you have enough equity in your home, sometimes you can obtain a home equity line of credit even if you’ve lost your job. You’ll only pay interest on the portion you use. But you’ll still have to make a monthly payment, so make sure you’re able to afford the new loan payments before you put your house on the line.

If you’re still strapped for cash, consider withdrawing from your tax-deferred retirement accounts, such as your IRA or employer-sponsored retirement Any money you withdraw from these types of accounts likely will be taxed as ordinary income for the year in which you make the withdrawal. Also, you may have to pay a 10% penalty tax for early withdrawal if you’re under age 59½ unless an exception to the penalty applies.

Tip: If you’re considering taking funds from your IRA or retirement plan, you should consult a tax advisor regarding the specific tax treatment of your withdrawal, because not all of it will necessarily be taxable. For example, if part of the withdrawal from your traditional IRA or employer’s retirement plan represents nondeductible contributions, you may not be taxed on that portion of the withdrawal.
If all else fails

If money really starts getting tight, be prepared to take more drastic steps. You might consider moving from your home and renting it temporarily. Obviously you’d have to find cheaper alternative housing, but the rental income from your home may be enough to cover your rental expenses while your tenants pay for most of the home costs, such as utilities and even real estate taxes. However, any decision you make in this area should be made with careful consideration, and only after evaluating how much you can actually get out of the deal.
As a last resort, you may have to consider selling bigger items like your car or even your home. Since these larger possessions usually carry a debt, by selling them you’re not only generating some cash, but you’re decreasing your expenses by ridding yourself of the debt attached to the item sold.

All is not lost

A job loss is not the end of the world, even though it may feel that way. Mapping out your priorities and drafting a bare-bones budget can help you come up with your own financial strategy for job loss survival.

Wayne Brewer
Financial Advisor
Waddell & Reed
888-569-6690
wbrewer40265@wradvisors.com

The accompanying pages have been developed by an independent third party. Forefield’s content and information is provided for informational and educational purposes only. Neither Forefield Inc. nor Forefield Advisor provides legal, tax, insurance, investment or other advice and should not be relied upon for such purposes. Waddell & Reed does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific financial planning and investment needs, please discuss your individual circumstances with your Financial Advisor.

The accompanying pages may include information regarding retirement plans, estate planning, business planning or a variety of other topics that involve tax and legal issues beyond the scope of Waddell & Reed’s area of practice and expertise. Such information is intended to explain or illustrate planning topics, options or strategies that you may wish to consider in advance of, or at the time of, seeking the assistance of legal and/or tax advisors in implementing your plans and should not be considered as an authoritative or comprehensive explanation of any of the particular planning topics, options or strategies described. The information in the accompanying pages describes the general aspects of various planning topics, options or strategies but does not necessarily address all the pertinent facts and issues of your personal situation.

Waddell & Reed does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice or may be relied on for the purpose of avoiding any federal tax penalties. The selection of appropriate planning options or strategies should be made on an individual basis after consultation with appropriate legal, tax and financial advisors. It is important that you retain the services of legal counsel to plan and implement any legal documents that you may require and that you consult a tax advisor for an explanation of the tax effects of any particular planning options or strategies on your personal financial situation.

Waddell & Reed financial advisors are able to offer insurance products through arrangements with insurance companies. Guarantees provided by insurance products are subject to the claims-paying-ability of the issuing insurance company.

There are currently three
ways to fund a Roth IRA–you
can contribute directly, you can
convert all or part of a traditional
IRA to a Roth IRA, or you can
roll funds over from an eligible
employer retirement plan
(more on this third method
later.)
In general, you can contribute
up to $5,000 to an IRA (traditional,
Roth, or a combination
of both) in 2008 and 2009. If
you’re age 50 or older, you can
contribute up to $6,000 in 2008
and 2009. (Note, though, that
your contributions can’t exceed
your earned income for the
year.)
But your ability to contribute
directly to a Roth IRA depends
on your income level (“adjusted
gross income”; or MAGI), as
shown in the chart below:
Regardless of whether you
contribute directly to a Roth
IRA, if your MAGI is $100,000
or less, and you’re single or
married filing jointly, you can
convert an existing traditional
IRA to a Roth IRA. (You’ll have
to pay income tax on the taxable
portion of your traditional
IRA at the time of conversion.)
But if you’re married filing separately,
or your MAGI exceeds
$100,000, you aren’t allowed
to convert a traditional IRA to a
Roth IRA.

What’s changing?

In 2006, President Bush
signed the Tax Increase Prevention
and Reconciliation Act
(TIPRA) into law. TIPRA repeals
the $100,000 income limit for
conversions, and also allows
conversions by taxpayers who
are married filing separately.
What this means is that, regardless
of your filing status or how
much you earn, you’ll be able
to convert a traditional IRA to a
Roth IRA.
The bad news? This provision
of the new law doesn’t take effect
until 2010.

So why concern yourself
with this now?

Even though the new rules
don’t take effect until 2010,
there are steps you can take
now if you want to maximize
the amount you can convert at
that time. If you aren’t doing
so already, you can simply start
making the maximum annual
contribution to a traditional IRA,
and then convert that traditional
IRA to a Roth in 2010.
Your ability to make deductible
contributions to a traditional
IRA may be limited if you (or
your spouse) is covered by an
employer retirement plan and
your income exceeds certain
limits. But any taxpayer, regardless
of income level or retirement
plan participation, can
make nondeductible contributions
to a traditional IRA until
age 70½. And because
nondeductible contributions
aren’t subject to income tax
when you convert your traditional
IRA to a Roth IRA, they make
sense for taxpayers
contemplating a 2010 conversion
even if they’re eligible to
make deductible contributions.
And don’t forget that SEP
IRAs and SIMPLE IRAs (after
two years of participation)
can also be converted to Roth
IRAs. You may want to consider
maximizing your contributions
to these IRAs now, and then
converting them to Roth IRAs
in 2010. (You’ll need to set up a
new IRA to receive any additional
SEP or SIMPLE contributions
after you convert.)

But there’s a taxing problem

If you’ve made only nondeductible
contributions to your
traditional IRA, then only the
earnings, and not your own contributions,
will be subject to tax
at the time you convert the IRA
to a Roth. But if you’ve made
both deductible and nondeductible
IRA contributions to your
traditional IRA, and you don’t
plan on converting the entire
amount, things can get complicated.
That’s because under IRS
rules, you can’t just convert the
nondeductible contributions to
a Roth and avoid paying tax at
conversion. Instead, the amount
you convert is deemed to consist
of a pro-rata portion of the
taxable and nontaxable dollars
in the IRA.
For example, assume that
in 2010 your traditional IRA
that contains $350,000of taxable
(deductible) contributions,
$100,000 of taxable earnings,
and $50,000 of nontaxable
(nondeductible) contributions. You can’t
convert only the $50,000 nondeductible
(nontaxable) contributions to a Roth.
Instead, you’ll need to prorate the taxable
and nontaxable portions of the account.
So in the example above, 90%
($450,000/$500,000) of each distribution
from the IRA in 2010 (including any conversion)
will be taxable, and 10% will be
nontaxable.
You can’t escape this result by using separate
IRAs. The IRS makes you aggregate
all your traditional IRAs (including SEPs and
SIMPLEs) when calculating the taxes due
whenever you take a distribution from (or
convert) any of the IRAs.
But for every glitch, there’s a potential
workaround. In this case, one way to avoid
the prorating requirement, and to ensure
you convert only nontaxable dollars, is to
first roll over all of your taxable IRA
money (that is, your deductible contributions
and earnings) to an employer retirement
plan like a 401(k) (assuming you have
access to an employer plan that accepts
rollovers). This will leave only the nontaxable
money in your traditional IRA, which
you can then convert to a Roth IRA tax free.
(You can leave the taxable IRA money in the
employer plan, or roll it back over to an IRA
at a later date.)
But even if you have to pay tax at conversion,
TIPRA contains more good news-
-if you make a conversion in 2010, you’ll
be able to report half the income from the
conversion on your 2011 tax return and the
other half on your 2012 return.
For example, if your only traditional IRA
contains $250,000 of taxable dollars (your
deductible contributions and earnings) and
$175,000 of nontaxable dollars (your nondeductible
contributions), and you convert
the entire amount to a Roth IRA in 2010,
you’ll report half of the income ($125,000)
in 2011, and the other half ($125,000) in
2012.

And speaking of employer retirement
plans…

Before 2008, you couldn’t roll funds over
from a 401(k) or other eligible employer
plan directly to a Roth IRA unless the dollars
came from a Roth 401(k) account or a Roth
403(b) account. In order to get a distribution
of non-Roth dollars from your employer
plan into a Roth IRA you needed to first
roll the funds over to a traditional IRA and
then (if you met the income limits and other
requirements) convert the traditional IRA
to a Roth IRA. And, as described earlier,
you needed to aggregate all your traditional
IRAs to determine how much income tax
you owed when you converted the traditional
IRA.
The Pension Protection Act of 2006
streamlined this process. Now, you can
simply roll over a distribution of non-Roth
dollars from a 401(k) or other eligible plan
directly (or indirectly in a 60-day rollover)
to a Roth IRA. You’ll still need to meet the
$100,000 income limit for 2008 and 2009.
tax on any taxable dollars rolled
over.
One benefit of this new procedure
is that you can avoid the proration
rule, since you’re not converting a
traditional IRA to a Roth IRA. This
can be helpful if you have nontaxable
money in the employer plan
and your goal is to minimize the
taxes you’ll pay when you convert.
For example, assume you receive
a $100,000 distribution from
your 401(k) plan, and $40,000 is
nontaxable because you’ve made
after-tax contributions. You can
roll the $60,000 over tax free to a
traditional IRA, and then roll the
after-tax balance ($40,000) over to
a Roth IRA. Since only after-tax dollars
are contributed to the Roth IRA,
this rollover is also tax free. (Both
your plan’s terms, and the order in
which you make the rollovers, may
be important, so be sure to consult
a qualified professional.)

Is a Roth conversion right for
you?

The answer to this question depends
on many factors, including
your income tax rate, the length of
time you can leave the funds in the
Roth IRA without taking withdrawals,
your state’s tax laws, and how
you’ll pay the income taxes due
at the time of the conversion. And
don’t forget—if you make a Roth
conversion and it turns out not to
be advantageous, IRS rules allow
you to “undo” the conversion (within
certain time limits).
A financial professional can help
you decide whether a Roth conversion
is right for you, and help you
plan for this exciting new retirement
savings opportunity.
The accompanying pages have been developed
by an independent third party.
Forefield’s content and information is
provided for informational and educational
purposes only. Neither Forefield Inc. nor
Forefield Advisor provides legal, tax, insurance,
investment or other advice and should
not be relied upon for such purposes. Waddell
& Reed does not guarantee theiraccuracy
or completeness, and they should not
be relied upon as such. These materials are
general in nature and do not address your
specific situation.
For your specific financial planning and
investment needs, please discuss your
individual circumstances with your Financial
Advisor.The accompanying pages may
include information regarding retirement
plans, estate planning, business planning or
a variety of other topics that involve tax and
legal issues beyond the scope of Waddell &
Reed’s area of practice and expertise.
Such information is intended to explain
or illustrate planning topics, options or
strategies that you may wish to consider in
advance of, or at the time of, seeking the
assistance of legal and/or tax advisors in
implementing your plans and should not be
considered as an authoritative or comprehensive
explanation of any of the particular planning
topics, options or strategies described.

The information in the accompanying pages
describes the general aspects of various
planning topics, options or strategies but
does not necessarily address all the pertinent
facts and issues of your personal situation.
Waddell & Reed does not provide tax or legal
advice, and nothing in the accompanying
pages should be construed as specific tax
or legal advice or may be relied on for the
purpose of avoiding any federal tax penalties.
The selection of appropriate planning options
or strategies should be made on an individual
basis after consultation with appropriate legal,
tax and financial advisors. It is important
that you retain the services of legal counsel
to plan and implement any legal documents
that you may require and that you consult
a tax advisor for an explanation of the tax
effects of any particular planning options or
strategies on your personal financial situation.
Waddell & Reed financial advisors are
able to offer insurance products through arrangements
with insurance companies.
Guarantees provided by insurance products
are subject to the claims-paying-ability
of the issuing insurance company.

Wayne Brewer
Financial Advisor
Waddell & Reed
888-569-6690
wbrewer40265@wradvisors.com