The Smartest Way to Use Unemployment Benefits

Prioritize your needs over debt when you’re on an unemployment budget

A recently laid-off IT employee contemplates what to do with his unemployment benefits.
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Antonio_Diaz / Getty Images 

Even if you’re a meticulous budgeter, a job loss will throw your finances for a loop. You’ll have to re-evaluate your spending and your priorities, which can be extra tough because losing a job often takes a heavy emotional toll. Throughout the pandemic, expanded unemployment benefits have been a lifeline for millions of Americans.

There’s no one-size-fits-all solution for surviving on an unemployment budget. In this article, we’ll cover some effective strategies for how to spend your benefits, how to adjust your budget, and which expenses to prioritize.

How Unemployment Benefits Work

The U.S. Department of Labor oversees the unemployment insurance system, but each state administers its own program, sets its own rules, and provides most of the funding. During ordinary times, a typical state unemployment program will replace about half of the average wage for up to 26 weeks, but benefits vary widely. In February 2020, before job losses became widespread due to COVID-19, average weekly benefits were $387. Mississippi offered the lowest weekly benefit at $215, while Massachusetts paid the highest at $550 per week.

The Coronavirus Aid, Relief and Economic Security Act (CARES Act) provided $600 a week of federal funds for unemployed workers on top of the regular state benefits. With that weekly supplement, which expired in July 2020, about 76% of unemployed workers were eligible to make more from unemployment than they had earned from the jobs they lost.

The latest relief bill passed in December 2020 supplements regular state benefits with an extra $300 a week, plus $100 for some self-employed workers, through March 14, 2021.

First, Plan for Taxes

Your jobless benefits are considered taxable income for federal taxes. That means you must report any unemployment compensation when you file your tax return. You can opt to have 10% of your benefits withheld for taxes by filling out IRS Form W-4V, but doing so is voluntary. There’s also no guarantee that 10% will cover your tax obligation, and you can’t choose to have more money withheld.

Thirty-five states also tax unemployment benefits. However, your benefits aren’t subject to the payroll taxes that fund Social Security and Medicare

 If you can have the 10% withheld and still have enough to pay for your basic expenses, by all means do so. But if you’re struggling to pay bills, not having taxes withheld is often the better move, according to Leslie Tayne, a New York-based debt settlement attorney and founder of the Tayne Law Group. 

“If receiving untaxed unemployment benefits will prevent you from choosing a predatory loan or having to borrow money with excessive interest, it might make sense to avoid withholding and [to owe] money when filing your taxes,” Tayne said in an email to The Balance.

If you can’t afford to pay at tax time, it’s essential that you file a tax return anyway to avoid additional penalties and interest.

The IRS is offering various payment plan adjustments and tax-repayment breaks for people who owe taxes. It may also waive installment-plan setup fees if your income is equal to or less than 250% of the federal poverty level.

Adjust Your Spending

When you’re making an unemployment budget, consider which expenses you need for survival. Tayne suggested ranking expenses from most to least important. 

“Groceries, mortgage and rent payments, utilities, and health insurance are essential,” she said. “If you’ve been paying down credit card debt and face unemployment, shift the focus to more important bills and pay the minimum on credit cards, if needed.”

Take a hard look at the expenses that show up on the “least important” end of your list, and consider what you can cut, like a gym membership, subscription, or streaming service. 

Even on basic expenses, you may be able to find ways to cut costs, particularly on groceries. 

“Consider shopping at low-cost grocery stores in your area, where available, such as Lidl and ALDI,” Tayne said. “Food staples are often much cheaper there compared to regular grocery stores.”

Other options during tough times include getting groceries from a food pantry or sharing meals with family and friends.

You may also be able to save on medications by switching to generics or using a prescription discount card. 

Prioritize Your Rent

Although a nationwide ban on most evictions has been extended through March 31, 2021, it’s essential to prioritize rent in your unemployment budget. When the moratorium ends, back rent will still be due, plus landlords can tack on late fees and interest.

Ask for Hardship Agreements if Necessary

If your unemployment benefits don’t cover all your bills, ask your bank or credit card company for a hardship agreement

Many banks are no longer advertising COVID-19 relief programs, but they may still allow you to spread out or push back payments on a case-by-case basis. If you’re a homeowner affected by COVID-19 and your mortgage is federally backed or insured, you may be able to pause or reduce your payments for up to 360 days. 

You will be responsible for paying back any mortgage payments that you paused through forbearance.

Build Your Emergency Fund

For a lot of people, a job loss is one of the reasons to have an emergency fund in the first place. But if you have money left over from your unemployment benefits after taking care of the essentials, consider putting it toward your rainy-day fund before you pay more than the minimums on your debt. 

Why focus on creating an emergency fund now? Your emergency fund will provide you with a safety net in case the extra unemployment benefits expire before you find your next job. Having secure housing, keeping your utilities on, and maintaining adequate food and health care are all more important than paying off debt. Saving cash now helps ensure that you can cover necessities or unexpected expenses without going deeper into debt.

After you have three to six months’ worth of expenses nestled away, you can turn to your high-interest debt. 

Focus on High-Interest Debt

If your emergency fund is set up and you’ve covered your essential costs, you may find you have money left over to put toward debt. In this case, prioritize the debt with the highest interest rate. For most people, that will be credit card debt, considering that the average interest rate is 20.28%.

What about student debt? Payments and interest on student loans owned by the Department of Education are suspended through Sept. 30, 2021. If you have federal student loans, consider taking advantage of the moratorium to build your emergency fund and then pay down debt that’s accruing interest. If you have private student loans, contact your servicer to ask whether they offer hardship programs. For example, SoFi has offered up to 90 days of forbearance for people in certain financial situations. 

The Bottom Line

Unemployment compensation is typically meager, but recent relief measures have made benefits more generous than usual. For some people, expanded benefits still won’t stretch far enough. If that’s the case, it’s essential to ask for hardship agreements and scrutinize your spending.

But if you have money left over from your benefits, use the extra cash to build a savings cushion first. Once you have a minimum of three months’ savings, tackle your debts, starting with the one with the highest interest rate.