I Have an Emergency. I Need Cash. Now What?

Transcript of Podcast Episode 201

Perhaps the most basic and often repeated rule of financial planning is this: make sure you have an emergency fund, because you never know. But what if that dreaded day comes along, and you don’t have an emergency fund. What are you supposed to do now?

It happens more than many people think. A home or car maintenance issue. A medical emergency. An unexpected legal bill. You need money fast, and your emergency fund, if it exists at all, is way short of the amount you need. Do you have any other, less expensive alternatives than maxing out your credit cards?

A recent article in Financial Advisor magazine took on this question and came up with some ideas. Certainly, not all of them would apply to everybody, and having a solid emergency fund is still the best option, but these suggestions are almost certainly better than the exorbitant interest rates charged by most credit cards. Here they are:

1. Home equity. With real estate values going up in the past few years, borrowing against your home has become a more popular option. Two of the more popular strategies are a home equity line of credit (HELOC), and a reverse mortgage.

A HELOC is in many ways like a credit card against your house. You can borrow money as needed up to the limit set by the bank. But the HELOC normally comes with a variable interest rate which is significantly less than a credit card. That said, as general interest rates have gone up in the past year, so too have the rates on your HELOC.

A reverse mortgage is primarily used by older people in retirement. Basically, you borrow against the value of your home and in most circumstances, receive the money as a fixed monthly payment. You don’t have to make regular payments back to the lender on your reverse mortgage, but the entire amount will be due when you sell the home or die.

Using a reverse mortgage is a complex strategy, and fees can have a significant impact. For many people, it is not seen as an attractive option.

2. Life insurance. Cash value life insurance can help provide you with funds when you need them the most. And in many circumstances, it can provide you with those funds on a non-taxable basis.

Certain whole life policies provide guaranteed cash values and many offer non-guaranteed value, as well If you have a sufficient amount of cash value to meet your need, there may be several ways to access it. Depending on the policy, you will probably be able to take a policy loan against it, the proceeds of which are generally non-taxable and restricted by the amount of the cash value. Interest on the loan will be payable as stipulated in the contract. Another possibility is to simply make a withdrawal of some of the cash value from the policy. Such withdrawals are generally non-taxable up to the amount of the premiums that you paid into the policy. Policy provisions determine availability of withdrawals.

The types of policies and benefits they provide can vary significantly. Your Security Mutual life insurance advisor can help you sort through the provisions of each type of policy and help you figure out what is best for you and your family.

3. Annuities. Most annuities provide some form of cash value. But there may also be surrender charges for anything considered an “early” distribution. In some cases surrender charges can last as long as 10 years.

And this doesn’t always work well when you consider taxes. Withdrawals taken from annuity contracts are generally deemed distributions and are therefore taxable to the extent of any gain. And if the annuity is inside a qualified plan, you can’t withdraw funds before age 59½ without incurring an additional 10 percent penalty. This comes in addition to the income tax due.

4. Borrowing from a 401(k). Some 401(k) plans allow you to borrow up to $50,000 from your account.

This is one option that many people find attractive, but there are some significant drawbacks. For one thing, you must pay interest on the loan at a rate specified by the plan administrator, and you generally must pay back the loan within five years.

Most people who do this end up putting their retirement savings on hold until the 401(k) loan is repaid. And if you lose your job while the loan is still outstanding, you must pay back full amount, usually within a couple of months, or the loan will be considered in default.

Things get worse if you default on a 401(k) loan. The outstanding balance is treated as taxable income, and if you’re below age 59½, you also will be charged a 10 percent penalty for making what is considered an early withdrawal.

5. Taking Early Withdrawals From Retirement Accounts. Other than maxing out your credit cards, this is likely to be the least attractive alternative. Taking money out of a qualified retirement plan is fully taxable. And worse yet, if you haven’t reached age 59½, it will usually trigger an additional 10 percent penalty.

But there may be ways to get around the penalty in certain circumstances. This is known as a “Substantially Equal Periodic Payment.” You use an IRS formula to calculate annual distributions for a minimum of five years or until you reach age 59½, whichever comes later, without the 10 percent penalty. But beware: you still have to pay income tax as you receive the money. In addition, once you begin receiving your substantially equal periodic payments, any modification or termination before the end of the required time period (other than death or disability), will result in a reinstatement of the ten percent penalty plus interest.

If you need to raise money fast, very often there are sources of cash that you may not have considered. These are just a few of them. But each has its own advantages and disadvantages. If you have this type of need, contact your local Security Mutual life insurance advisor. He or she can coordinate with your other advisors to help you figure out your best options.

 The information presented is designed to provide general information regarding the subject matter covered. It is not to serve as legal, tax or other financial advice related to individual situations, because each individual’s legal, tax and financial situation is different. Specific advice needs to be tailored to your situation. Therefore, please consult with your own attorney, tax professional and/or other advisors regarding your specific situation.

 To help reach your goals, you need a skilled professional by your side. Contact your local Security Mutual life insurance advisor today. As part of the planning process, he or she will coordinate with your other advisors as needed to help you achieve your financial goals and objectives. For more information, visit us at SMLNY.com/SMLPodcast. If you’ve enjoyed this podcast, tell your friends about it. And be sure to give us a five-star review. And check us out on LinkedIn, YouTube and Twitter. Thanks for listening, and we’ll talk to you next time.

The applicability of any strategy discussed is dependent upon the particular facts and circumstances. Results may vary, and products and services discussed may not be appropriate for all situations. Each person’s needs, objectives and financial circumstances are different, and must be reviewed and analyzed independently. We encourage individuals to seek personalized advice from a qualified Security Mutual life insurance advisor regarding their personal needs, objectives, and financial circumstances. Insurance products are issued by Security Mutual Life Insurance Company of New York, Binghamton, New York. Product availability and features may vary by state.