There are many aspects of financial planning, but for many people engaged in this task, their primary focus is on accumulating assets for retirement, estate planning, paying for college, or meeting other short- or long-term goals. Although building an emergency reserve is one of the primary facets of financial planning, few advisors or their clients really believe a layoff or other job loss is a real possibility. This column examines some of the nitty-gritty aspects of planning that are often overlooked when clients assume, “It can’t, or won’t, happen to me!” It can, and very likely will.
If you’ve been doing annual reviews with your clients and going over their investment account statements, you already have the means to answer the next few questions:
- How many of your clients have been laid off, fired or just quit their jobs in the past year?
- How many are (still) looking for a job?
- How many had adequate reserves of cash and other liquid, nonretirement assets to continue to provide for basic needs when their income was reduced or became nonexistent?
- Did your annual review include a strategy to make sure they planned for the financial ramifications of loss of one (or more) income streams?
- What were you able to do for them?
THE TIME TO GET THE LINE IS WHEN THE JOB IS NOT ON THE LINE.
When you discuss financial planning and the future with your clients, here are a few items you might want to add to your list of questions and approaches.
How well-funded is your emergency reserve? If there is one thing all advisors agree on, it’s this: Everyone needs an emergency reserve that is liquid, readily accessible, and not subject to penalties or significant amounts of tax. But how much is enough, and how many clients even come close to that amount?
OK. Let’s say three to six months of take-home pay is the figure you and your clients have agreed on. Is the money there? Are your clients making regular financial contributions to make sure the money will be there if it is not there yet?
Supplementing the emergency reserve. There are other means to supplement the ballyhooed emergency reserve. Not to take its place—to supplement it. Here are the most commonly used ones, and not all are necessarily desirable planning tools, just inevitable ones!
Let’s go from the ones that don’t dramatically affect other areas of the financial plan to those that blow holes right through the middle of everything.
Unemployment compensation. The rules vary by state and by cause of unemployment. Many people are entitled to collect unemployment, but their pride won’t allow them to do it. This is not a good financial move. If someone was laid off or even let go for other reasons, he is usually entitled to unemployment.
Does your client know how much he (and his spouse) will be entitled to in the form of unemployment insurance? This is a valuable (but taxable) source of cash to stretch out the emergency reserve. Even better, your client may be able to work part-time while looking for a new job and still collect most or all of the unemployment.
Home equity. Using the money in a home for the purposes of buying insurance or investing is a no-no. But when your client is out of a job and needs cash, accessing some of the equity in his home is probably a better choice than maxing out credit cards at 15 percent to 21 percent or more, cashing out the money in a qualified retirement plan or surrendering an annuity or life insurance policy.
Of course, once your client’s job is history, it may be very hard for him to get a home equity line of credit. So a bit of preplanning goes a long way. The time to get the line is when the job is not on the line.
There are at least two major downsides to this option. You can reduce these risks by knowing your client and doing a bit of advising:
Pitfall No. 1: Having a first mortgage and a home equity line that exceed what the house will sell for (after allowing for selling expenses).
Pitfall No. 2: Some clients can’t keep their hands off something as tempting as the checks and the credit card, which are the usual means to access the line of credit.
Retirement accounts. It is quite feasible to liquidate part or all of IRAs, company retirement plans, and so forth. Of course, the deferred taxes and IRS-imposed 10 percent penalty will easily eat up 30 percent to 50 percent or more of the money. Clients don’t seem to understand that the 20 percent an employer withholds is rarely enough, and IRAs often have nothing withheld when they are cashed. This is a truly bad option. If your client just needs a supplemental income, try collecting all the available qualified plan money into one IRA and then using the “substantially equal withdrawals” option to get money without the 10 percent penalty.
Other options. Last, but far from least, some clients have assets that are earmarked for retirement supplements, college or other expenses. These are usually taxable and accessible.
Some clients may also have significant cash value in life insurance, but tapping this money could quickly impact the sustainability of the policy.
With all of life’s many unexpected twists and turns, a little preplanning goes a long way. No one is immune from job loss, but proper planning will prevent the financial ramifications from becoming disastrous.
Janet Arrowood is the managing director of The Write Source Inc. She can be reached at info@TheWriteSource.org.