My financial planning practice is a diverse one. Since 1995, more than 80% of my business has involved working with clients who have been laid off or have retired early. To give you an idea of the magnitude of my work, I stopped counting after my 20,000th client.
The short-term financial planning I do for these clients is not based on any formal training—everything I have learned has been through experience. This is mostly due to the urgency of the work involved. Long-term financial planning resumes once the client is back in the workforce. An advisor who can safely guide the client through a jobless period will have a client for life.
There are a number of critical areas our clients must understand if they are to make informed decisions. During career transitions, short-term financial strategy is more important than long-term financial planning. Clients need to know what they have to do to survive the financial and emotional upheaval they will endure in these periods of transition. The key concerns are cash management, taxation and tax deferral, benefit replacement, employment insurance, and pensions or company savings plans.
My job is to lessen fear and misinformation so the client can focus on finding a job rather than on finances. It is important to see your client as soon as possible after a termination. The timing of the intervention can make a huge difference in the client’s financial security. For the laid-off employee, not knowing important financial information can hurt in the short term and have lasting long-term consequences.
This is usually the client’s first and most acute fear. The client’s key concern is how he is going to pay the bills. My experience is that most people do not know where they are spending their money. The most important question to ask is how much cash the client needs, and how much he currently has on hand. With the prevalent use of credit and debit cards, we have been mismanaging our way to financial hardship.
Clients need to understand what their priorities are and remove any spending that doesn’t contribute to survival. I ask my clients to do an analysis of where they have been spending their money. My role as a financial planner is to assist the client in putting a formal cash management system in place, or, if one already exists, to assist with fine-tuning the current system.
We first look at all debt being serviced by the former employment cash flow. Where severance is a continued salary, this arrangement still needs to be reviewed because this source of cash will end.
If the client is not re-employed at the end of her salary continuance, she will need additional funds before employment insurance (EI) commences and to supplement EI. Some of the questions that need to be explored are: Can the mortgage be re-amortized? Can other loans be serviced by interest payments only? Should we pay off the credit cards and lines of credit with the severance, since we can re-access them in the future?
We need to get spending down to a reasonable amount. We also need to ensure there is a small reserve of funds so the client and the family can have fun. This helps the client with much-needed stress relief.
Taxation and tax deferral
Taxation and tax deferral play a pivotal role in determining the availability of cash for the downsized employee. It is important to understand which components of the severance are earned income (reported on a T4), such as Employment Standards Code payments or salary continuance, and which are retiring allowance (reported on a T4A).
All employers deal with this issue differently, so you must read the severance letter to know how this money will be taxed in the client’s hands. Retiring allowances are taxed differently at source and therefore can be manipulated differently to facilitate the client’s financial survival through the transition.
We can use the client’s RRSP contribution room to facilitate a reduction in taxes held at source for the retiring allowance in order to increase the amount of available cash that the client can use to pay her bills.
By redeeming RRSP funds as needed, the client can stretch the severance to last a longer time for financial survival. The downside of using RRSPs to increase available cash is it creates a tax liability for the future, since severance payments and RRSP withdrawals are fully taxed, though they are taxed differently at source. The other downside is the permanent loss of RRSP contribution room. You must make the client aware of the pros and cons of these options so she can make an informed decision on which to pursue.
Depending on the client’s province of residence, benefit replacement can be a real and significant issue. Some provincial employment codes require the former employer to maintain the benefits for the equivalent time the severance covers. Other provinces do not have these measures in their legislation. If the client has run out of coverage, there are three important areas that he may need to replace.
The client has 31 days from termination to convert her life insurance to a personal policy without proof of medical insurability. The limitation is usually the former coverage or $200,000, whichever is less. Some insurers are providing up to $1,000,000 in convertible insurance. Time can be of the essence here, depending on the age and amount of insurance required. The key question to answer is whether the client will have enough time to put a personal policy in place. Some insurance providers do allow the conversion of spousal coverage as well.
Few carrier companies provide for conversion and portability of disability policies. In many cases the client has no means of obtaining disability insurance, though a few companies do provide specific transitional disability policies.
You should complete a needs assessment, and if the client’s assets are significant enough to allow for a comfortable retirement, disability insurance may not be required.
EXTENDED MEDICAL AND DENTAL BENEFITS
This is the proverbial “dog’s breakfast” of financial planning. Recently, several group providers have created a portable version of the employer’s benefit program. Depending on the province in which the client resides, these may be the only logical option, especially if there are pre-existing medical conditions. Unfortunately, this option tends to be quite expensive. The Province of Alberta sponsors a drug coverage plan that does not exclude pre-existing conditions. Coverage is immediate if the employee applies within 30 days of losing his company coverage.
Most employers provide electronic Records of Employment directly to Service Canada after terminating the employee. Some still provide paper copies. The client needs to apply for EI as soon as possible to avoid being disqualified. The duration and amount of employment benefits vary across the country, depending on the regional unemployment rate, the last time the client applied for EI benefits, and the number of hours the client worked.
Company savings and money purchase pension plans
Company savings plans usually fall into two categories: registered or tax-deferred, and non-registered or tax-paid. The carrier will usually contact the client and provide him or her with the documentation required to move these funds to appropriate personal accounts.
A: Company RRSPs can be transferred to the client’s individual RRSP.
B: Company Deferred Profit-Sharing Plans (DPSPs) can be transferred to the
client’s individual RRSP. DPSPs can only be combined with an RRSP after the termination of employment.
C: Money Purchase Pension Plans (MPPP), also known as Defined-Contribution Pension Plans (DCPP), can be transferred to a personal locked-in retirement account. Each province and the Federal Pension Standards Act have various names for the locked-in retirement accounts. Also, in each case the legislation differs on the transferability of small benefit amounts that can be cashed in and taken into income or transferred to the person’s RRSP. This will be outlined in the documentation from the carrier.
DEFINED-BENEFIT PENSION PLANS
Defined-benefit pension plans need to be handled cautiously, since no two DB pension plans are exactly alike. Many advisors assume they can automatically commute the value of the pension and transfer the proceeds to a locked-in vehicle. In many cases untold damage has been done to a client due to ignorance on the part of the advisor.
To properly evaluate whether or not to commute, you need to thoroughly understand the age of the client, years of pensionable service, ancillary benefits such as indexing, and early retirement discounting. If you cannot understand this material, find someone who can. The client’s long-term financial health may be at stake.
Non-registered plans are typically stock purchase accounts, though not exclusively so. Whether funds are transferred in kind or cashed in, there may be tax as well as timing issues that need to be understood so the client can make an informed decision.
Some clients will have stock options, Stock Appreciation Rights (SARs) and Restricted Share Units (RSUs). The vesting periods, availability and tax treatments of these funds can vary substantially from company to company. The termination letter and company documentation provided at the granting of these benefits will hold the key information. If the information is not clear, the client needs to contact her human resources department. This area requires complete understanding when you are attempting to determine what the client actually has upon involuntary termination.
Losing a job is much more than losing a pay cheque: it represents the loss of personal security, such as insurance and savings. For the client, this is a time of reflection and significant worry about the future. The career transition client desperately needs good financial planning counsel at this critical point in her life. If you help the client through this time, your client will stay loyal—and it’s always easier to keep a client than to find a new one.