Don’t do anything I explain to you in today’s column.
That is, unless you’re really, really in a bind.
Despite the best-laid plans of earnest investors and savers, things sometimes go awry and money is needed in a hurry. That’s common coming out of a prolonged period of economic and investment malaise.
Emergency money is just that: something you go to when there’s no place else to turn. Financial planners preach the philosophy of keeping three to six months worth of expenses on hand. For retirees, a full year’s worth of expenses makes sense. But once you’ve rifled through that money (if you put it aside in the first place), where do you turn next?
Not everyone agrees what funds you should tap first, but there’s agreement that this should not be done casually. Vacations or luxury cars do not merit such measures.
“The home equity line of credit would be my first choice in an emergency because it’s very quick once in place, simply requiring that you write a check,” said Marilyn Capelli Dimitroff, certified financial planner and president of Capelli Financial Services Inc., Bloomfield Hills, Mich. “I advise working people to have one set up ahead of time as a safety net, since it’s much easier to do when you have income.”
The interest on this revolving credit is tax deductible. There’s a large final payment and your home is used as collateral. The interest rates are relatively low, but always shop for the best deals on rates, closing costs and fees. .
“The insurance policy would be my number one place for emergency money because the interest charge is very low and you can delay payment of the principal or, if you wish, not pay it back at all,” said Roy Diliberto, certified financial planner and president of RTD Financial Advisors Inc. in Philadelphia. “If you don’t pay it back, the money just comes out of the policy’s proceeds when the inevitable [death] occurs.”
Loan provisions vary enough among cash value policies that you should carefully examine yours before deciding, Diliberto cautioned. Obtaining a loan requires a verbal or fax request. It won’t be denied. The maximum you can borrow depends on how much cash value your policy has accumulated.
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“When borrowing from a policy, make every possible effort to pay the loan back because that’s just good overall financial planning,” advised Randy Kilgore, secretary of the National Association of Insurance & Financial Advisors (www.naifa.org) in Falls Church, Va., who borrows from his personal policies because he finds it cheaper than going to a bank.
Your individual retirement account is a less inviting port in the storm.
“While there’s nothing that says people can’t tap their retirement funds for an unexpected crisis, we don’t encourage it because it makes it that much harder to put together their nest egg,” warned Robert Corcoran, vice president of retirement services for Fidelity Investments in Boston. “But if they do decide to take money out, their next consideration is how to do so without paying penalty tax or [in some cases] income tax on the money.”
First-time homebuyers, people paying college expenses and the disabled can withdraw money from a traditional IRA without incurring the 10 percent IRS penalty for early withdrawal. It’s also possible to “annuitize” your account to avoid the 10 percent penalty. In this process, for five years or until you turn age 59 1/2, you take annual cash withdrawals based on your life expectancy as predicted by the IRS. All of the above situations require that you pay tax on the withdrawal.
However, with a Roth IRA you can take your principal out at any time penalty-free and tax-free. You can also take your earnings out if you’re 59 1/2 and the money has been in the Roth IRA at least five years.
The loan feature of 401(k) retirement plans is highly touted.
“Eighty-five percent of 401(k) plans have a loan feature that places no restrictions on why you can borrow and these loans can be generated over the phone or Internet,” explained David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America. “There are usually expenses such as a plan loan fee and annual administrative fee, each of which is probably about $100.”
You can borrow half your 401(k) account balance up to $50,000 and you usually repay the loan in 60 equal monthly payroll deductions over a five-year period. Rate is usually the prime rate plus 1 percent. Warning: Many companies do not give a grace period on your loan if you terminate employment, so you might have to pay off the entire loan as quickly as your next pay period.