Taking a leave of absence from work? Here’s what you should know.

Thinking about taking a leave of absence from work? There are certain circumstances under federal and state laws, where unpaid leave must be offered and your job is protected. Before you take an unpaid leave of absence, there are some financial aspects you should consider. Unlike paid time off, with a leave of absence, you might not collect a paycheck while you're gone. Without a plan, that could impact your cash flow, savings and retirement. 

There are many reasons why people take a leave of absence, often driven by a life event such as childbirth, adoption, sickness or military leave. Either way, preparing for the weeks or months without income will help you afford the costs associated with your time off.

Types of leave of absence

There are two types of leave of absence: mandatory and voluntary. With mandatory leave, your employer is required to give you up to 12 weeks off without pay under the Family Medical Leave Act (“FMLA”). Once the time is up, you’re given your previous job back or an equivalent one. Under FMLA, you’re eligible for non-paid time off for the following reasons:

Voluntary leave doesn’t have the same protections as FMLA. Your employer sets the terms for this employee benefit, and your job may not be safe when you return. Reasons to take voluntary leave may include: 

Determine your pay gap

A large impact of a leave of absence is the hit to your income. With no paycheck coming in, it can be difficult to stay afloat. That’s why it’s important to know your pay gap ahead of time, so you can come up with a plan to cover the shortfall. 

There are several ways to shore up cash for your leave of absence. Cutting discretionary spending, getting a part-time job and reducing bills can all increase savings. Paying down your debt should be a focus too. When your income is lower, you don’t want to miss payments and get hit with fees and penalties during your leave. That can negatively impact your credit score, making it costlier to borrow if that becomes necessary. Try to save three to six months of expenses prior to your departure. 

Additionally, you can consider reorienting your investment portfolio to generate income as an alternative – or addition – to savings. Specifically, if any of your investments pay a dividend, you can withdraw them without having to sell the stock that pays them.

Retirement impact

Any time off from work without pay probably means you are not contributing to your employer-sponsored retirement plan, if you have one. The money already in your 401(k) can continue to be invested, but your contributions will most likely stop for the weeks or months you are out of work. To prevent any retirement savings shortfall down the line, consider increasing your contributions, within the allowed limits, before your leave. Your contributions may benefit from the effects of compounding, which over time can help you make progress toward your retirement goals.

What happens if you have to sell investments

Even if you’ve planned, you may find that you need access to more cash. Or, if the leave of absence is an emergency and you don’t have money saved, you may need to turn to assets that you originally wanted to leave alone. Consider consulting with a financial advisor to see if it might make sense for you to re-orient your portfolio to generate more income than growth.

You may think it’s a good idea to either tap into your 401(k) during your time off or borrow from your retirement plan if your plan allows, but both options can hurt you down the road. If you take a distribution, pre-tax money will be treated as taxable income, and if your distribution is an “early withdrawal” you may also get hit with a 10% penalty. Not to mention, it’s highly recommended to leave your 401(k) untouched if at all possible to avoid impacting your retirement goals. Consulting with a financial advisor may help to navigate your situation – and you should of course consult with your tax and legal professional before making any decisions.

If you have taxable investment accounts, you can withdraw money without risk of penalty, but you have to weigh the pros and the cons before making this move. Sure, you’ll have money to live off of, but you could end up selling the investment earlier than planned or at a less-than-perfect time. You’ll lose the potential for that investment to grow, the long-term compounding effects, and if there’s a profit, you’ll have to pay capital gains taxes.

If you still want to do it, stick to selling investments you had for more than a year to reduce your potential tax hit as these will be long-term capital gains, which get taxed at a lower rate than short-term capital gains.

Borrowing funds

In an emergency, you may have to borrow. There are different options like accessing home equity loans or lines of credit or securities-based lending, where you borrow against your investments. Or you could use credit cards. While providing a way to pay expenses, your debt load can increase and all of these options have risks, which you should understand before borrowing.

Borrowing from friends and family is another option, but has its own risks since, if you can’t pay it back, it can cause a strain in your relationship.

Leaves of absence are part of life, but they don’t always have to set your finances back. Planning and saving prior to your hiatus from your job can prepare you to weather the storm and help keep your financial goals on track, even if you are detouring for a little bit.

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