While not exactly a fun exercise, do you know where you’d turn for some extra cash in an extended emergency? Morningstar has 10 Sources of Emergency Cash, Ranked from Best to Worst which contains many good points, but I would differ in my rankings.
I wondered about severity and duration. Is this money you expect to be able to pay back within a year, or is it a one-time permanent expense? You may not know the answer for sure, but for the purposes of this list I will assume that I become unemployed for an extended period and can’t start paying the loan back for 12 months.
1. Do the legwork and delay, defer, or work out a payment plan. Many lenders will work with you if you are in a temporary cash crunch, but you have to take the initiative. It may be possible to defer mortgage payments, put your student loan into forbearance, or get other forms of relief. By delaying any of these bills and ideally adding the payment due to the end of your term, you can save cash now for something else that can’t be put off until later.
2. Existing emergency fund. The standard advice is to keep 3-6 months of expenses in a liquid savings account. Has there been a reliable study on how many households actually have this? I would keep a little held back if possible and move down to the next available option below.
3. Sell the stuff. If you own things you don’t truly need, like a second car, timeshare, boat, jewelry, or other non-essential assets, it may be time to sell even at a loss. Your pride shouldn’t come in the way of protecting your family’s financial security.
4. 0% APR credit cards. Sure, credit card interest rates can be very high, but that’s because they can’t take away your house, car, or 401k balance away from you if you can’t pay it back! This is an important detail! If you’ve been taking good care of your credit score, you can score some low-interest financing for over a year. You can either go for a 0% APR balance transfer or simply put everything possible on your card to take advantage of 0% APR for purchases. If I was really hurting, cashing one of these 0% APR checks I keep getting and paying an upfront 3% balance transfer fee would be fine. If you don’t have them lined up yet, you should apply before you lose your job, as the credit card companies are tracking your employment nowadays and they may know if you’ve been laid off recently.
5. Taxable brokerage account. If you have stocks and bonds held outside employer plans and IRAs, these are fair game to sell. If I was really paying 17% interest, I would pay off the credit cards with some of this. I would first stop reinvesting dividends and start taking them as cash. Most places say to sell your bonds because they probably have minimal capital gains and haven’t dropped significantly in value during a crisis. You may also look for stock lots with tax losses that you can harvest. Again, it would depend on the tax situation; I might move on below if the expense is a temporary one.
6. Margin loans. Don’t want to sell some of your positions? Margin loans are backed by the value of your brokerage assets, and you can get it as cold hard cash. The risk is that if your collateral (stocks, bonds, ETFs, mutual funds) drop steeply in value, your broker will force you to sell them to cover your loan. That could be a double-whammy of badness! Therefore, you should only borrow a very small percentage of the available amount. (In other words, this option is best if you have a big brokerage balance.) If you believe there is a good chance you will use this feature, consider moving your account over to Interactive Brokers as they have some of the lowest margin rates available (currently 1.55% on $25k). Margin requirements can get a little complex, see this Fidelity article.
7. Home Equity Line of Credit (HELOC). Here’s another place I differ from Morningstar. I would much rather draw some money from my HELOC at about 5% interest for maybe a few months to a year than pull out a Roth IRA contribution that I can’t replace ever again. The catch here is that during a crisis, many banks may stop accepting applications or even freeze your existing HELOC. As of this writing, Wells Fargo and Chase have already stopped opening up new HELOCs. You should set one up now and not wait to pull money out at the last minute.
8. IRA “Loan” (CARES Act.) This is specific to right now. The CARES Act now allows you to take up to $100,000 out of your IRAs, after which you have 3 years to put it back into your IRA again without penalty or tax. It’s kind of like a really long rollover window. However, you will owe income tax on whatever partial amount is not put back within 3 years. This is called a coronavirus-related distribution (CRD) and is limited to those affected by the coronavirus (ex. diagnosed with COVID-19, experienced a layoff, furlough, reduction in hours, or inability to work due to COVID-19, or lack of childcare because of COVID-19.)
9. Life insurance cash values. I don’t have any whole life insurance myself, but built-up cash values seem like an acceptable place to draw some money in a true emergency. The loan option seems to be more complicated.
10. 401k loans. If one person in the household has a job that is very secure, then a 401k loan can offer a very low interest rate. You also pay the interest back into the 401k balance, so the only effective “cost” of the loan is that you will pay income tax on the interest an extra time. For example if the interest rate is 8% and your marginal income tax rate was 25%, you’d only effectively be paying 2% interest. The CARES Act now allows you to take out 100% of the vested balance, up to $100,000. The risk with a 401k loan is that if you get laid off, you must pay back the loan within 90 days or it will count as an unqualified withdrawal (taxes + penalties) until you are over age 59.5.
Everything else. Other options may include taking Social Security early, taking out a reverse mortgage on your home, and other forms of personal loans. My overall theme is that I want to protect my tax-sheltered assets if possible. I don’t want to touch my Traditional IRA, Roth IRA, 401(k). These are meant to grow for decades and decades, and since the contribution amounts are limited each year, I can’t get them back once I have taken them out as a hardship withdrawal.
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