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Retirement Planning When You Don't Have a Job

January 25th, 2010 at 01:38 am

When you were still lucky enough to be employed, you may have faithfully contributed to your retirement through payroll deductions directed into your 401(k). Now that you're out of work, there's no point in even considering continued retirement planning until you find your next job, right?

Wrong. While it's true that for most jobless people, retirement contributions may have to be put on hold, there are still important steps you can take to manage your existing retirement assets.

1. Rebalance your portfolio.
If you haven't rebalanced your portfolio lately, it's important to do so now. With stocks having rebounded sharply higher since last spring, your stock/bond/cash weightings may be out of kilter with your intended asset allocations.

You should be rebalancing at least once a year, and the start of 2010 is an ideal time to do so, since performance data from 2009 is readily available. By rebalancing now, prudent investors will be able to lock in gains by selling some of their winners and buying weaker-performing funds at bargain prices. They'll also be able to restore diversification - a key tool in managing risk - in their portfolio.

2. Convert to a Roth IRA.
For most individuals who believe their tax bracket in retirement will be higher than in their earlier working years, a Roth IRA is preferable to a traditional IRA. That's because with a Roth IRA, while you don't get a tax break when you make contributions, after age 59 1/2, all your withdrawals, including accumulated earnings, can be taken tax-free.

Compare that to traditional IRAs, which are taxed upon withdrawal, based on the tax bracket you fall into at the time of withdrawal.

Despite the more favorable tax treatment of Roth IRAs, the stumbling block preventing many from converting traditional IRAs to Roth IRAs has been the hefty tax bill that can often come due from such a conversion, since the amount converted is added to your income and is subject to tax.

That's why long-term unemployment or underemployment can make a Roth IRA conversion a much more doable event with a much less painful tax bite.

If you've been out of work or underemployed for a while, this could be an ideal time to take advantage of your lower tax bracket and convert your IRA to a Roth IRA. The conversion could cost you very little. (Remember, in 2010 there are no income limits restricting who can do a Roth IRA conversion.)

Consider such a tax-advantageous move only if you have adequate savings and won't hurt yourself by paying the IRA conversion tax bill.

3. Don't Write Off Retirement Contributions Completely.
Granted, sudden unemployment has a way of helping one prioritize very quickly. The distinction between "necessity" and "discretionary" becomes very clear as you end up cutting cable TV, eating out, your kid's dance lessons or pending home improvements in favor of paying the mortgage, utility bills and health insurance.

The problem is, when you stop retirement contributions "temporarily," whether due to joblessness, underemployment or self-employment, it can be difficult to catch up to where you should be later. When you land your next job, you may wind up deferring retirement contributions for longer by telling yourself you have other more pressing needs for your newfound money.

Despite the unavailability of an employer-sponsored 401(k) plan, those who are determined to save for retirement even during a challenging employment period can do so. In addition to funding your Roth IRA or traditional IRA, you might also consider opening a SEP IRA if you've turned to self-employment or freelance work to help you get by. You can contribute 25% of your net income, up to $49,000.

(If you're planning on doing a Roth IRA conversion this year, it might be best to avoid opening any new SEP IRAs because it could increase your tax bill on the Roth IRA conversion.)

Another attractive option for self-employed individuals is a solo 401(k) plan. Unlike a regular 401(k) plan, a solo 401(k) plan is only available to self-employed individuals or small business owners who have no other full-time employees (unless it's the owner's spouse).

A solo 401(k) plan lets you save for retirement as employer and employee. As a sole proprietor, you can contribute 25% of your net income, up to $49,000. And as your own employee, you can contribute up to $16,500 more.

Fully funding any of these retirement vehicles may seem like wishful thinking when you're struggling to get by, but even a modest contribution of $50 or $100 a month can make a big difference over time, thanks to compounding interest and investment gains.

Skip doing so and you may have to do an all-out sprint in later years to make up for lost time.

A job layoff doesn't have to mean your retirement planning is stopped dead in its tracks. Even if there's nothing extra to put toward retirement savings, being mindful of your investments and positioning them appropriately can help keep your long-term retirement plans from being derailed by a temporary setback.

Consult your financial adviser for recommendations based on your personal circumstances.

3 Responses to “Retirement Planning When You Don't Have a Job”

  1. creditcardfree Says:

    Great article! Did you see my post about our roth conversion plan? We are taking advantage of our lower taxable income to convert our ira's to roths this year.

  2. fern Says:

    Thanks. Yes, I think I saw mention of your doing that this year. I'm glad you can do it.

  3. davera Says:

    Nice article, Fern.

    I miss hearing about you! If you're up for it, fill us in on your doings.

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