How To Prepare Your Finances For A Drop In Income

About half of people in the United States are satisfied with their jobs, according to a 2023 Pew Research study. This suggests the other half wants something better. Demanding schedules, tedious work and toxic environments could all be factors causing people to want to leave their positions. Dropping your job to pursue a passion or further your education can lead to a temporary or permanent drop in income. Here is how to plan for that adjustment and some opportunities that arise from the career change.

Reevaluate Your Financial Goals

Whether you are taking a permanent or temporary income hit, it likely impacts your financial goals. Let’s say you’re a big city tech employee who earns $200,000. In that environment, you may have similar goals as coworkers and friends. Maybe you want to buy a house, have an art collection and save significant money for retirement.

However, if your true passion is music and you have been dreaming of playing the guitar full time, those financial goals may change. Perhaps then, you’d want to move where you have more opportunities to play and you’d save a little less money to support a simpler lifestyle.

During every major life event, it is critical to reflect on what is important to you and potentially be flexible on goals you’ve held in the past. Take time to write down your own goals and rank them in order of importance.

Reassess Your Budget

If you are taking an income cut, it is vital to understand your monthly spending. For most people I work with, their initial guess is much less than the reality of what they are spending. When you have plenty of excess income, these mistakes and rounding errors are not a big deal. However, when you need to live on less money, sticking to a budget is crucial.

Essential spending will include things like housing, utilities, bills, insurance and groceries. Nonessential spending categories will include things like subscriptions, eating out, vacations, and entertainment. If your income will be dropping dramatically, it may be time to evaluate making cuts to your nonessential spending categories.

Ensure An Ample Emergency Fund

While you still have the higher income, it’s important to ensure that your emergency reserves are padded. When your income is being reduced, try to have six months of average spending in reserve to ease the adjustment period.

Strategize Your Taxes

Having a reduced income can present tax opportunities for both retirement accounts and standard nonretirement investments.

Nonretirement investments are subject to capital gains taxes when you sell assets that have increased in value. Your capital gains income bracket is dependent on a combination of your earned income and the amount of financial growth the asset has accumulated.

Let’s go through an example. A single woman lives in the state of Washington, and she has held a stock for two years that has $100,000 in growth. She has a job that pays her $200,000 this year but plans to take a year off working next year. If she sold her stock this year, she would pay $18,800 in capital gains taxes. However, if she waited until next year when she has $0 in earned income, she would only pay $6,053 on the sale.

If you hold pretax retirement assets and would like tax-free income in the future, you can use years with reduced income to convert portions of pretax retirement accounts to Roth. When you convert pretax retirement assets to Roth investments, you pay income taxes in the year of the conversion but when you draw money in retirement, it is tax-free. When you are in a lower-income bracket, less taxes apply to the conversion.

Conclusion

Choosing to pursue a new career, take a break, or gain education can be rewarding but it requires a little extra planning. Take this time to reevaluate your goals, reassess your budget, bulk up your emergency reserves, and strategize your taxes.

This article was originally published by me on Forbes.

This informational and educational article does not offer or constitute, and should not be relied upon as tax or financial advice. Your unique needs, goals and circumstances require the individualized attention of your own tax and financial professionals whose advice and services will prevail over any information provided in this article.  Equitable Advisors, LLC and its associates and affiliates do not provide tax or legal advice or services. Equitable Advisors, LLC (Equitable Financial Advisors in MI and TN) and its affiliates do not endorse, approve or make any representations as to the accuracy, completeness or appropriateness of any part of any content linked to from this article.

Cicely Jones (CA Insurance Lic. #: 0K81625) offers securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors in MI & TN) and offers annuity and insurance products through Equitable Network, LLC, which conducts business in California as Equitable Network Insurance Agency of California, LLC). Financial Professionals may transact business and/or respond to inquiries only in state(s) in which they are properly qualified.  Any compensation that Ms. Jones may receive for the publication of this article is earned separate from, and entirely outside of her capacities with, Equitable Advisors, LLC and Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC).  AGE-6633879.1 (05/24)(exp. 05/26)