02/09/2011 01:33 pm ET Updated May 25, 2011

Don't Let a Layoff Catch You Unprepared

Chances are you or someone you know has been laid off during the recent economic downturn. Being unemployed is difficult enough, but in a cruel twist, the longer someone is out of work, the harder it can be to find a job. And when work does finally materialize, it's often a lower-paying position.

This double whammy can damage your finances for years to come.

If you've recently been laid off or worry that your job may be in jeopardy, there are several steps you should take immediately to protect yourself financially:

Investigate severance benefits. Employers aren't obligated to provide severance benefits unless they're part of an employment agreement, but it doesn't hurt to ask. Use knowledge of your company's severance policies -- and what other laid-off employees have gotten -- as leverage to negotiate a better package.

Common severance benefits include:
  • Severance pay, usually based on annual wages and years of service.
  • Extended health care insurance and assistance paying premiums.
  • Temporary use of company resources, such as office space or equipment.
  • Outplacement counseling, which may include assistance with resume writing, interview skills development and job searches.

If your company doesn't offer outplacement services, visit CareerOneStop, a Department of Labor-sponsored website featuring career resources and connections to local career centers that provide employment and training opportunities.

Apply for unemployment benefits. Depending on your length of employment and other factors, you may qualify for unemployment insurance payments. The waiting period is based on the date you file, not when you lose your job, so apply immediately. Click HERE for a link to unemployment benefit information in your state. Reminder: These benefits are subject to income tax.

Rein in expenses. Even if you've built up a considerable emergency war chest, long-term unemployment can devastate your savings. Analyze your budget carefully and track all expenses, looking for non-essentials to trim (unnecessary vehicles, eating out, cable TV, new clothes, etc.)

Manage your bills. Ordinarily, making extra mortgage, loan and credit card payments is a great financial strategy, but if you're facing unemployment, it may make sense to scale back payments to boost your available savings to pay bills. Just be sure to always make at least minimum payments -- on time; otherwise, you risk facing higher interest rates and damaging your credit score.

Also, this may be the one time when it makes sense to suspend 401(k) contributions in order to accumulate more cash. If you later determine your job is safe, ask whether your employer will allow a year-end catch-up contribution.

Seek additional income. Consider renting out a spare room, selling unneeded items or taking a part-time job. However, be aware that part-time job income could impact your unemployment benefits, so check the rules carefully.

Protect your 401(k). After being laid off, you have several options for your 401(k) balance:
  • If allowed, leave it in your former employer's plan (although, if it's less than $5,000, you may be required to close the account).
  • Roll it over into a new employer's plan, if it has one.
  • Roll it over into a regular or Roth IRA. (With a Roth, you'll pay income tax on the amount when filing this year's taxes; however, you won't be taxed on subsequent earnings at retirement).
  • Take a lump-sum cash payout.

Although the last option may sound tempting, especially if you're short on cash, it's rarely a good idea. Not only does it significantly reduce your retirement savings, but you'll face severe tax consequences: You'll owe federal (and possibly state) income tax on the amount, plus a 10 percent early withdrawal penalty unless you're over age 55 or disabled.

Also note that outstanding 401(k) loans must be repaid, usually within 30 to 90 days of leaving your job, or you may owe taxes and an early distribution penalty if you're under age 59 ½. Consult a financial professional to learn more about the financial consequences of 401(k) distributions. If you don't know one, the Financial Planning Association is a good place to start your search.

Polish your resume. Make sure yours stands out from the crowd, accurately reflecting your accomplishments and showing potential employers that you have the experience, drive and qualifications they seek. Use concise, strong language and an organized appearance. It's a good idea to update your resume regularly, especially after a promotion or changed job responsibilities.

Alert your network. Let family and friends know you're looking; they may know about opportunities or spread the word on your behalf. Seek out networking events sponsored by the Chamber of Commerce, local colleges, trade associations or other business and social organizations -- even volunteer work.

Track job-search expenses. If you itemize income tax deductions, many job-search-related expenses are deductible if your combined miscellaneous itemized deductions exceed 2 percent of your adjusted gross income. These expenses include:
  • Costs to produce resumes and business cards
  • Phone calls and postage to mail materials to prospective employers
  • Unreimbursed travel and transportation expenses
  • Unreimbursed career counseling and outplacement agency fees.
  • Refer to IRS Publication 529 for details.

Being laid off can be very stressful and expensive, but if you're prepared with a good game plan, you can minimize the damage to your financial well being.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.

To participate in a free, online Financial Literacy and Education Summit on April 4, 2011, go to Practical Money Skills.