"You're fired" might be the most dreaded phrase in the workplace. But "You're furloughed" is quickly earning a bad reputation, too. In response to the coronavirus economic crisis, Macy's, Kohl's, Gap, Disney, and Marriott International have all announced large-scale employee furloughs. Hundreds of thousands of workers in retail, entertainment, and hospitality are affected.
A furlough is an unpaid leave of absence from work. It's similar to getting fired, in that you don't report to work, you don't get paid, and you may lose some of your benefits. The primary upside to a furlough is that it is intended to be temporary. Your employer does want you back at your post once the company's situation improves.
Getting furloughed obviously hurts your income, and it can affect your 401(k) too. Thankfully, your 401(k) investments will stay put through the furlough. Your savings won't be mailed to you in a check, nor do you have to roll them into another account, as might be the case if you were terminated. But there are still other outcomes to be aware of. Here are three of the most important.
1. Contributions will be paused, mostly
You're not earning a paycheck during the furlough, so there's no way for you to contribute to your 401(k). You'll lose your matching contributions during this time too.
The only type of deposit you might still see in your 401(k) is a nonelective employer contribution. Nonelective describes contributions that employees can receive without electing to contribute out of their own salary. These are usually discretionary profit-sharing contributions that employers make after the end of a successful fiscal year or quarter. If your employer chooses to make a profit-sharing contribution, all employees benefit, including those on furlough. Is that likely to happen? Unfortunately, no, as employers are probably conserving cash and declining the added discretionary expense.
So, without any 401(k) contributions or paycheck, you probably don't have the cash to save in a different account. What you can do is review your retirement plan and decide which of these strategies feels right:
- You can delay retirement. That gives you time to save and make up for the missed contributions during the furlough.
- You can downsize. This is challenging to implement now, but you can look at the future possibility of moving to a smaller home or cheaper neighborhood. Lowering your living expenses can allow you to increase contributions once you get back to work. And if you keep that streamlined lifestyle into retirement, you'll take a lot of pressure off your savings.
- You can delay your Social Security claim. You can start benefits as early as age 62 or as late as 70. Hold off on claiming for another six months or one year, and your monthly benefit increases. If you can afford to wait, the higher monthly benefit could make up for a few months of missed contributions.
2. Vesting may be affected
Employers normally don't give you full ownership of your matching contributions - that ownership is phased in over time, which is called vesting. You might be 25% vested in the first year, 50% vested at the start of the second year, 75% in the third year, and fully vested at the start of the fourth year. If you split with the employer before the fourth year, the unvested employer contributions are removed from your account.
But what happens if you were employed for 10 months, and then furloughed for three? Are you then vested at 25% or 50%? It depends on how the vesting schedule is defined. Often, the vesting schedule will reference duration of time as an employee. In that case, your time on furlough counts toward that duration. But if your vesting schedule is defined as hours of service, the answer is different. Your time on furlough won't contribute to your vesting, because you're not accumulating hours of service.
There's also a scenario where you could skip the vesting schedule and be fully vested immediately. That could happen if you are left on furlough for an extended period of time, or ultimately laid off. When an employer terminates 20% or more of its workforce, that triggers what's called a partial plan termination. An extended furlough might also initiate a partial plan termination at the IRS' discretion. When that happens, your employer must vest all affected employees to 100%.
3. Ability to borrow and repay may change
Every plan defines its own rules for 401(k) loans. If the plan allows any employee with an available 401(k) balance to borrow, then you could take out a 401(k) loan while on furlough. But if the rules require you to be active or in service, then a 401(k) loan may not be allowed. If you're in need of cash, check with your plan administrator on the loan rules. Alternatively, you can also pursue a penalty-free withdrawal of up to $100,000, made possible by the CARES Act.
You'll need to check in with your plan administrator if you already have an outstanding 401(k) loan. Being that you aren't getting a paycheck while on furlough, your repayments will stop. Get ahead of a potential default by asking your plan administrator about your options. Your employer may provide another means for you to make payments, or (even better) suspend your loan repayments temporarily.
Keep an eye on your retirement plan
As your situation unfolds, stay on top of how it affects your 401(k) balance and retirement outlook. Hopefully, this furlough is just a bump in the road with respect to your career and your retirement plan. But if it evolves into a longer-term proposition, be ready to change your retirement timing or increase your contributions in a big way once you get back to work.