Covid-19 Update (Part 2): How Do I Manage/Find Cash in a Crisis?
Topics: Emergency savings, Taxable and Roth accounts, HELOCs/Cash-out Refi, 401K loans, CARES Act
In our last post (Covid-19 Update Part 1) we talked about some strategies to take advantage of current markets, but now we’re shifting gears to talk about what you might do if you’re in need of cash in a crisis. While ideas presented here are written because of the Covid-19 crisis, they apply to any situation where there’s a cash crunch due to a big change in your life (job loss, buying a house, having kids, etc.).
As the world struggles to grasp the impact of Covid-19, and fellow Americans continue to fight for their lives, the near-term impact of this crisis has produced record unemployment claims. If you’re in need of cash, hopefully you can tap your own asset base, but if not, we discuss some options. This is certainly not an exhaustive list but applies if you have a cash flow shortage.
So what are your options to locate cash?
- Emergency savings/reducing your savings rate/Spending less
- Using financial assets (taxable accounts/Roth contributions)
- Borrowing (from family or friends, 401K, home equity line of credit/cash out refi, personal loan)
- Credit Cards/cash out of 401K/IRA
Before we get into the details:
- If you’re looking to cut costs our Cash Flow Management service can help, and I believe it can pay for itself. Or you can sign up for Free expense tracking as well.
- If you are in need of budgeting assistance, check out our post (How Do I Get Out of Credit Card Debt and Start a Budget?)
- If you’re curious about your net worth, ready to start your Financial Plan or outsource your Household CFO duties, start here by creating your own Right Capital login.
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On a personal note
I’m far removed from the worst impact of Covid-19 so far, and I’m already a germophobe/introvert that works from home. Plus, as other Costco shoppers know, you’re somewhat prepared for a self-isolation event buying in bulk. At any given point we easily have 2 months’ worth of toilet paper in our house! So the biggest changes in my life are that I’m a bit more OCD about hand-washing for me and my family (I did sanitize my credit card and phone for the first time ever!), and my kids are now home-schooled.
I realize home-schooling is difficult. I get the best part of it as my kids’ PE teacher, so we play outside much more than I would in a normal day when they’re at school. We’ve also enjoyed more meals together, outdoors time, more Quiet Time and overall quality family time. I hope you too have found something to enjoy in these challenging times.
But I see how the self-isolation can be a big deal for others. And I’m also very aware of the stats of this Coronavirus, including how its spread, and how contagious it is and the current mortality rate. But still I remain hopeful!
Ok let’s talk about some options to find cash in a crisis:
Emergency savings or reducing your savings rate/spending less
The ideal option is to tap into the Emergency Savings you’ve built up – that pot of dollars that contains 3-6 months of expenses. Another similar alternative is to lower your savings rate – the dollars you have automatically deducted from your checking account to your savings. Or if you’re saving for retirement – recall we note a 15% savings rate to get you to adequate and timely retirement in a recent post (How Much Money Do I Need to Save for Retirement?) – ratchet that back down to make up the shortfall (if possible). Of course, finding ways to spend less is also a great option (if that’s difficult check out our Cash Flow Management service). Ideally if you don’t have a lump of cash for emergencies, some combination of lower savings and expense reduction will help you make up your lost income.
Financial assets (taxable accounts/Roth contributions)
This assumes you have been investing over the years, but you’re a bit short on cash Emergency Savings. While its less than optimal to sell assets when everyone else is, it’s time to get a bit more creative. You may have to pay taxes on capital gains (but not for withdrawals). However, the recent market downturn could make that a little less onerous – you may be able to reduce your taxable income by selling assets at a loss. Secondarily, you can take contributions out of a Roth IRA without penalty or taxes, but earnings must stay until you are 59.5 and have the account at least 5 years. I put selling from a taxable account ahead of the Roth for the tax benefits, but this is debatable depending on ability to avoid near-term capital gains. So those forgotten taxable and/or Roth accounts might come in handy – account consolidation is part our Asset Management service (just FYI).
I’m talking about borrowing from anywhere other than from credit cards here. If you have friends or family that will extend you an interest-free or low rate loan, that’s definitely a good option. Other opportunities might be a home equity line of credit (I’ll include a cash-out refinance here too even though its neither borrowing nor a taxable event) because interest rates there are as low as 3-5% perhaps. You might be able to get a similarly low rate loan from your own 401K, though you are generally maxed out from borrowing the lesser of $50,000 or half your balance (read on for new rules about 401K withdrawals). A personal loan would provide a slightly higher interest rate than those as well but could be an option. Ranking these choices has some gray area given how people might feel about their prospects to repay (evaluating the worst-case scenario between losing your home or postponing retirement – both bad options).
The Last Resort (Credit Cards/cash out of 401K/IRA)
I lumped these together simply because I would hope you might avoid both. I know it’s easy and quite common to carry a balance on credit cards. As you’ve built up savings, my hope is that even carrying a balance “occasionally” would become unnecessary. Why? The average interest rate on credit cards is about 15%, so just about any other form of borrowing is a better option (except I suppose from a mob boss), yet more than half of America continually has a balance. Secondly, cashing out of your 401K or other tax-deferred account could give you a lot more liquidity to satisfy a major need, but the cash will be counted as income and taxed as such, not to mention will come with a 10% penalty. With the penalty, as well as state and local taxes, your withdrawn cash could be reduced by a third. It is noteworthy that the recent CARES Act will allow up to $100,000 to be withdrawn from your 401K penalty-free (but not tax-free), which may be helpful in a dire situation, but again, to the detriment of your retirement.
Bankrate has some ideas for your 401K here: https://www.bankrate.com/retirement/protect-your-401k-coronavirus-recession/
So in summary, your best option for cash in a crisis is obviously your Emergency Savings but having some flexibility in savings rate or expenses would be beneficial. After that, you could create liquidity from a taxable account or Roth IRA contributions, and lastly, hopefully you can locate some favorable borrowing options that aren’t plastic.
Please check out my blog posts for more financial topics:
If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: email@example.com.
And stay tuned for additional blog posts on retirement savings and other topics.
Best wishes on your financial path!
This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.
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