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Your Guide To Navigating Actions After Losing A Job: COBRA and Retirement Plans

December 17th, 2024 by Blake Pinyan

Losing a job can have a significant impact on your health insurance and other employee benefits. This article will be the first of two on this topic, specifically focused on COBRA and Retirement Plans.

Topics covered include:

  • Health Insurance and COBRA
  • Retirement Plans

Health Insurance and COBRA

COBRA Definition

Health insurance is a critical employee benefit. Upon job loss, it’s important to understand how your coverage may be affected. Maintaining health insurance is essential, as unexpected medical expenses can create severe financial consequences.

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) is a federal law that allows eligible individuals to temporarily continue their employer-sponsored health insurance coverage following a qualifying event, such as job loss.

Eligibility Requirements

To be eligible for COBRA, you must meet the following criteria:

  • Qualifying Event: You must experience a qualifying event, such as job loss, reduction in hours, or a change in family status.
  • Qualifying Health Plan: Your employer must offer a group health plan covering 20 or more employees.
  • Qualified Beneficiary: You must be a covered employee, spouse, or dependent.

Qualifying Events

COBRA can be triggered by various qualifying events, including:

  • Job loss (voluntary or involuntary)
  • Reduction in hours of work
  • Job transition
  • Death
  • Divorce or legal separation
  • Retirement
  • Medicare eligibility (for the employee)
  • Loss of dependent child coverage

Qualifying Health Plan

COBRA applies to private-sector employers with 20 or more employees. Part-time employees may be included in the count, but they are often counted as fractions based on their hours of work. The law does not apply to federal government or church-related health plans.

If you work for a company with fewer than 20 employees, you may not be eligible for COBRA. However, some states offer alternative coverage options, so it’s important to check with your state’s insurance department.

Qualified Beneficiary

To be a qualified beneficiary, you must have been covered by the health plan immediately before the qualifying event. This includes the employee, spouse, and dependents.

Election Period and Cost

You typically have 60 days from the date of the qualifying event or the date you receive the COBRA election notice to decide whether to enroll in COBRA coverage.

COBRA coverage is generally more expensive than employer-sponsored coverage because you’ll be responsible for the full premium, including the employer’s portion. However, some employers may offer subsidized COBRA coverage as part of a severance package.

Coverage Term

COBRA provides temporary continuation of health insurance coverage for 18 or 36 months, depending on the qualifying event. For job loss or reduction in hours, coverage can last up to 18 months. For other events like death or divorce, coverage can extend to 36 months.

COBRA coverage may end early under certain circumstances, such as:

  • Failure to pay premiums
  • Employer discontinuation of the health plan
  • Enrollment in a new health plan or Medicare
  • Engaging in fraudulent activity

Other Health Insurance Options

While COBRA is a common option for maintaining health insurance after job loss, it’s not the only choice. It’s essential to consider other alternatives, especially since COBRA premiums are often significantly higher than employer-sponsored coverage.

Spouse’s Employer-Sponsored Plan

If you’re married, consider your spouse’s employer-sponsored health plan. While it may not be as comprehensive as your previous plan, it could be more affordable than COBRA, especially if your spouse’s employer subsidizes the premiums.

State Health Insurance Exchanges

State health insurance exchanges, like Covered California, offer a variety of health insurance plans. These plans are often subsidized based on income, making them more affordable for low-income individuals and families. You can use the exchange’s online tools to compare plans based on factors like premium cost, deductible, and out-of-pocket expenses.

Medicaid

Medicaid is a government-funded health insurance program for low-income individuals and families. Eligibility requirements vary by state,  but generally you must meet income and asset limits.

Retirement Plans

The most common retirement plan is the 401(k). When you lose your job, you have several options for your 401(k). Other types of retirement plans (403(b), 457 plan, TSP, etc.) generally provide these same options:

  • Cash it out
  • Leave it where it is
  • Roll it into a new employer’s plan
  • Roll it into an Individual Retirement Account (IRA)

Cashing Out Your 401(k)

Cashing out your 401(k) involves withdrawing all or a portion of your funds. While this option provides immediate liquidity, it has significant drawbacks:

  • Tax Implications: If your 401(k) contributions were made on a pre-tax basis, the entire withdrawal, including earnings, will be subject to income tax. This could result in a significant tax burden, especially if you’re pushed into a higher tax bracket. Additionally, the IRS automatically withholds 20% of the distribution for federal taxes.
  • Early Withdrawal Penalty: If you’re under age 59.5, you’ll incur a 10% penalty on the taxable portion of the withdrawal.

Due to these tax implications and penalties, cashing out your 401(k) is generally not recommended unless it’s an absolute financial emergency.

Leaving Your 401(k) Unchanged

Another option is to leave your 401(k) with your former employer. While this may seem like the easiest choice, it can have drawbacks:

  • Investment Drift: Over time, your investments may drift from your original asset allocation, potentially leading to an asset mix that’s not in alignment with your financial goals, time horizon, and tolerance for risk.
  • Limited Investment Options: You’ll be restricted to the investment options offered by your former employer’s plan, which may have high fees and limited diversification.
  • Inactivity Fees: Some plans may charge fees for inactive accounts, further eroding your savings.

It’s important to consider these factors before deciding to leave your 401(k) with your former employer.

Rolling Your 401(k) into a New Employer’s Plan

Another option is to roll your 401(k) into your new employer’s plan. This can simplify your retirement savings by consolidating your assets into a single account. However, you’ll still be subject to the investment options and fees offered by your new employer’s plan.

Rolling It Into an IRA

The last option is to roll over your 401(k) into an Individual Retirement Account (IRA). This involves a tax-free direct transfer of funds from your 401(k) to an IRA.

Advantages

  • Investment Flexibility: IRAs offer a wide range of investment options, such as individual stocks, bonds, and ETFs. This allows for greater customization and provides an opportunity for active management.
  • Lower Investment Expenses: IRAs can have lower investment fees (expense ratios) compared to 401(k) plans if they are invested in stocks and/or low-cost ETFs. Mutual funds within a 401(k) can come with higher investment fees.
  • Roth Conversions: IRAs allow for Roth conversions, which can provide for a bigger tax-free bucket in retirement.
  • Professional Management: You can hire a financial advisor to manage your IRA investments, providing expert guidance and portfolio management.

Considerations

While IRAs offer many benefits, it’s important to be aware that IRAs may have higher fees than 401(k) plans if you decide to hire an advisor to manage the account. The investment advisor fee will ordinarily be higher than the 401(k)-plan administration fee.

Conclusion

Losing a job can be a significant life event and understanding the implications for your employee benefits is crucial. By being proactive, you are taking steps to protect your financial future.

At Anchor Bay, we’re committed to helping our clients navigate their employee benefits upon job loss. We provide guidance on decisions related to health insurance, retirement savings, and other benefits to ensure you make informed choices that align with your financial goals and objectives.