You’ve spent more than 20 years in one field—say, banking, law, or sales. You’ve dutifully built up equity in your home, saved a tidy sum for your kids’ college tuition, and stashed away a healthy retirement fund. It’s been a nice ride, but it’s starting to feel like the time to pursue a passion or a dream, or give something back to the world.
Why now? Perhaps your employer dangles an enticing buyout package, or you’ve simply hit a dead end. Or maybe a life-changing event, such as the death of someone close to you, is a wake-up call reminding you to act on your dreams before the opportunity is gone.
Whatever your motivation, you still need to be pragmatic: For most people, a midcareer restart comes with a financial price tag. It might mean a sizable pay cut to pursue work in a more altruistic field, a hefty tuition bill for more schooling, or a temporary loss of medical and retirement benefits.
Before plunging into a more rewarding second career, it pays to make a financial plan that will allow you to stick with your goals. If you’re likely to trade a good income for better work, first review your entire financial life, from everyday expenses to retirement funding. Then consider some of these money moves to set yourself up for success:
Chart a budget. If you’re going to be living on less, you probably need to trim expenses. Get a clear sense of your income, debts, and savings. If you don’t already have a monthly savings system, start one. Track your spending and ask what luxuries you can do without: Restaurants? Dry cleaning? Vacations? And as a rule of thumb, it’s smart to have a cushion of up to six months of living expenses set aside for transition costs, as well as unexpected emergencies.
Downsize. Depending on the real estate market where you live, it might make sense to move to a smaller home, or even relocate to a cheaper town, maybe Cleveland versus New York. When Cliff Stevenson chucked his 20-year mortgage-banking career to teach social studies to eighth graders and high school students, his salary plunged to about one-sixth of what he made in his best banking years. Stevenson and his wife, Diane, have no children, and they were able to sell their Victorian home outside Pittsburgh for twice what they paid, downsizing to a smaller townhouse. Now they don’t have a mortgage.
Take required courses before you quit. If possible, keep your current job while you add the education you need for your new pursuit. Many employers offer tax-free tuition assistance programs—up to $5,250, not counted as taxable income—and the contribution doesn’t have to be tagged for a full-degree program. You may have to repay the funds, though, if you don’t stay with the company for a certain number of years afterward.
If you’re going back to school, seek financial aid. You don’t need to be college-age to get a subsidized loan—there’s no age limit, and you’re eligible as a part-time student, too. The federal aid formulas don’t take into account your home equity or retirement accounts, and, as an adult, a certain amount of your savings is protected—usually from $20,000 to $60,000—depending on your age and marital status. To apply for aid, complete the Free Application for Federal Student Aid (FAFSA) form. You can get more information on what’s deductible from IRS Publication 970, as well as from the National Association of Student Financial Aid Administrators’ Tax Benefits Guide.
While it might be tempting to borrow from your home equity, you’re better off with a low-interest [www.staffordloan.com] Stafford loan. If you meet a financial needs test, the government will pay the interest for as long as you’re enrolled in school. The interest is currently a fixed rate of 6.8 percent, compared with about 8 percent for a home-equity loan. Many private lenders also offer loans, though rates will be higher.
Research scholarships and grants. These, too, are available for older students, usually offered by associations, colleges, religious groups, and foundations. Try sites such as FastWeb to find what’s available.
Take advantage of educational tax breaks. Depending on your income, you might qualify for the lifetime learning credit, worth up to $2,000 each year. There’s no limit to the number of years you can claim the credit. There’s also a maximum student loan interest deduction of $2,500. See IRS.gov or the tax benefits guide at NASFAA.org for details.
Get the most out of your health insurance, while you’ve got it. Maintaining consistent insurance coverage can be one of the toughest challenges. If you can, schedule medical, dental, and eye doctor appointments before you leave your job. Generally, your current employer must allow you to extend health and dental coverage for up to 18 months after you leave, under the COBRA Act of 1986. The catch is, you pick up the tab for the coverage—and it isn’t cheap.
The federal government has been subsidizing 65 percent of COBRA premiums for people who lost their jobs between September 1, 2008 and December 31, 2009 due to an involuntary termination. The program is drawing to a close but Congress is expected to extend the subsidy.
If COBRA doesn’t work for you, consider getting a new policy on your own.
Life and disability insurance is also important. If you won’t have employer coverage for a while, decide whether to purchase new insurance or convert your employer’s group policy to an individual policy. If your spouse works, check whether his or her coverage meets your needs.
Preserve your 401(k). When you leave your job, you’ll have the option of receiving a cash payout from your 401(k) plan. Don’t; it would be a big mistake. The money will be subject to federal and state income taxes. In most cases, if you cash out before age 59½, you’re hit with an additional 10 percent penalty. At the highest federal tax bracket, 35 percent, you could lose more than 45 percent of the pot. Ouch.
A smarter idea is to roll over your entire plan into an Individual Retirement Account. If you choose this option, make sure the money is transferred directly from the old plan to the new IRA. If your employer makes the check payable to you, the company is required to withhold 20 percent of the money for tax purposes. But be careful—this is where many people mess up. If your employer sends you a check for the remaining 80 percent, when you open your IRA, you must put up the missing 20 percent to avoid the penalty for taking a nonqualified distribution. You’ll get it back when you file your next federal tax return—but if you can’t post the 20 percent, it’s included in your gross taxable income. Importantly, if you don’t roll over the money you receive within 60 days, you’re subject to the 10 percent penalty for an early withdrawal as well.
If your new employer’s plan accepts rollovers, you can transfer the funds directly there. Many employers make you wait a certain period of time. If your account has more than $5,000, you can keep your funds in your former employer’s plan, where they’ll continue to accumulate tax-deferred. Later on, you can move them directly to another qualified plan without penalty. By then, with luck, you’ll be well on your way to the career you always wanted.
Kerry Hannon is the author of What’s Next? Follow Your Passions and Find Your Dream Job (Chronicle Books) available May 1, 2010. This article originally appeared in U.S. News and World Report.