Finding a source of emergency cash

July 13, 2008|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Hard economic times can call for cold, hard cash.

Whether financial pressure comes from rising gasoline and grocery bills, from a period without steady income or from a mortgage burden, emergency dollars are a necessity.

Ideally, people have established liquid emergency funds. In addition, spending needs to be reduced in difficult times. Beyond that, strategic decisions must be made on where to go next for money.

Credit cards are a terrible source for emergency dollars because they worsen the financial situation through high interest rates and mounting debt. Pillaging retirement accounts is another mistake. As a rule, piling on more debt from any source to pay off other debts can start a downward spiral.

The first consideration is the emergency fund. People often don't put enough into it, spend it on non-emergency items or tie it up in investments that carry too much risk.

"One of the biggest challenges is the temptation of seeing a pot of money, whether $10,000 or $1,000, that seems to be just sitting there doing nothing," said Evelyn Zohlen, a certified financial planner and president of Inspired Financial in Huntington Beach, Calif. "While it is difficult to leave it alone, it must be considered sacrosanct."

Investors should not get clever with emergency money.

"It should be thought of like money in your wallet," said Lance Alston, a certified financial planner with JWA Financial Group Inc. in Dallas. "When people start to think of it as an investment, they make decisions based on return rather than safety and move it around searching for best returns."

For an emergency vehicle, Alston recommends bank savings accounts, bank money market accounts and the money market funds of major fund companies or brokerages. Zohlen prefers bank certificates of deposit, noting penalties for early withdrawal are on earnings and not that burdensome.

"The old advice is three to six months of living expenses - not earnings, but living expenses," Zohlen said. "However, if you lose your job, it also depends on how marketable you are and how quickly you can replace your income." Respect the economy and rising costs, experts said.

Next, look to existing longer-term taxable investments to obtain cash. Examine your personal portfolio to see which stocks, stock funds, bonds or bond funds can be sold. Despite tax liabilities and potential redemption fees, you're not borrowing anything you'll have to repay. It is your money.

If circumstances force you to take money from a retirement account, Benz considers a Roth IRA the best place to start because you already have paid taxes on that money. You can withdraw Roth IRA contributions, but not earnings, you've made at any time without penalties or tax.

Early withdrawal from a traditional IRA is less desirable because it requires you to pay taxes, and you'll also incur a 10 percent penalty.

"If you've got cash value in a life insurance policy, this is a good time to take a loan on that," Zohlen said. "The last place to go is retirement savings, and especially a traditional IRA."

As far as life insurance cash value, you can withdraw money and have it deducted from the face value, or you can take a non-tax-deductible loan from the cash value.

Loans also can be available from employee 401(k) retirement accounts. But keep in mind that if you lose your job, you will have to pay the loan back promptly. Zohlen cautions that borrowers often don't repay those loans, and that company plans can require contributions be suspended if a loan has been taken out.

A much worse choice is actual withdrawal from a 401(k), which many companies permit only if you have used up other financing and there is urgent need. You will pay tax on the withdrawal and a 10 percent early-distribution penalty.

Another popular source for cash is the home equity line of credit, offering relatively reasonable interest rates if your credit is good. The most attractive feature is that all or part of the interest is tax-deductible.

Benz noted other cash sources:

*A reverse mortgage, which allows senior citizens to receive assets that represent their equity in their homes. If they leave the home, the borrowed amount plus interest is deducted from the home value.

*A margin loan, which permits borrowing against the value of securities in your brokerage account. The value of securities can fluctuate, however, and you will receive a margin call if they fall below a certain percentage.

Andrew Leckey writes for Tribune Media Services.

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