EMERGENCY CASH RESERVES – ALL SET?
During the financial crises, I’ll never forget the Friday that I got home from work and my husband told me he had been laid off, and his mother passed away the same day. It was a rough day for sure. And, I was grateful that we didn’t have to worry about financial obligations because our cash reserves were in place. Yes, I really thought about it that day. My husband was rehired 2 months later, which was a nice surprise. One can never know exactly what’s coming.
The reason for emergency cash reserves is in situations like the above. Job loss, medical issues, family or other urgent situations make establishing cash reserves a worthwhile endeavor.
The standard financial planning recommendation for emergency cash reserves is 3 months of expenses for a two-income household, or 6 months of expenses for a single-income household. The difference is due to the likelihood of a two-income household having one income earner employed if the other one loses a job. The employed person could bridge the gap, depending on income level.
More than 3 or 6 months of reserves produces greater peace of mind, which I am a big fan of. Does that mean you have to go for more? No, and you may choose to depending on your situation and goals. One of my personal money philosophies is “more is more”.
Emergency cash reserves are readily accessible funds that don’t involve incurring a cost or extra time to obtain. I have often been asked why cash reserves are recommended to meet living expenses in tough circumstances if one has assets in stocks, investment account(s) or retirement accounts.
The answer is: Emergency reserves are intended to be completely accessible when needed, and not subject to market risk, taxes or time delays to obtain. This is for the financial protection of the household.
What is complete accessibility? Cash on the barrelhead. Funds in a savings account (some are currently paying 4%+ with no balance requirement) can be accessed easily when needed. Invested assets in non-retirement or retirement accounts require a sale order, and they may require up to 3 days to “settle” (complete) the sale before funds are available for transfer to a cash account. If someone must sell invested assets to meet expenses, one could be forced to sell in a declining or advancing market, compounding the need for cash with a loss on an investment (capital losses are limited to $3,000 per year on your tax return under current tax laws) or incurring tax on capital gain.
If funds are taken from a tax deferred retirement account, the withdrawal is typically taxable at the federal and state level. If the account owner is under age 59 ½ there could be an additional tax penalty of 10% for early withdrawal. There are allowances for withdrawing up to $10,000 for financial emergencies without the 10% penalty, with federal and state income tax still required to be paid.
The following story is about real clients who were not thrown into a job-loss, medical or family emergency, but who nonetheless had a financial problem due to lack of liquidity. Their story is an example of what can happen when life intervenes, and liquid cash reserves aren’t available.
More is more!
Not Enough Cash to do What Was Needed
A retired couple was selling their long-time residence and needed to purchase their new home which was under construction and completion was months away. To secure the new home they had to make a deposit for which they didn’t have the cash – a liquidity problem. The only source of funds was an annuity which was in the early surrender penalty phase.
They couldn’t access equity from the existing home because it was on the market – and it was a slow sales market at the time. They sought advice from me. I asked why the annuity was obtained. They had sought help from their bank about how to secure more income for retirement and the representative sold one party the annuity as the answer, without evaluating their liquid assets position or asking about future plans. The only solution was to liquidate the annuity which cost them a $20,000 early surrender penalty.
They became investment clients after the sale of the existing home. Financial planning was very important for them, and the purchase of the new home. We helped them in planning for their future, reviewing and updating their living trust (via referring to trust attorney) retaining appropriate liquidity, generating new income streams from investments, and helping manage financial issues during their retirement.
Please call with any questions about reserves, or if you would like an Excel expense worksheet that we provide to clients. I’ll be glad to email it to you.
Written by: Ann Timoney Personal Financial Advisor, CFP® atimoney@opeswealth.com 408-981-1335 C
Disclaimer: Case Studies are provided for illustrative purposes only to provide an example of the firm’s client base, process, and methodology. The experiences portrayed herein are not representative of all firm clients. Other individual outcomes may vary based on their individual circumstances, and there can be no assurance that the firm will be able to achieve similar results in comparable situations. No portion of this case study is to be interpreted as a testimonial or endorsement of the firm’s financial and investment advisory services. Client tax situations are unique and specific, and you are encouraged to consult a tax professional to analyze your specific situation. This material has been prepared for informational purposes only, and is not intended to provide tax, legal or accounting advice; nothing contained in these materials should be taken as such. The opinions expressed in this article are not intended to provide specific advice or recommendations for any individual or on any specific tax strategy or security. The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Opes Wealth Management cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Advisory services are only offered to clients or prospective clients where Opes Wealth Management and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Opes unless a client service agreement is in place.
