Retirement Triage After a Crisis
When you're in the middle of an emergency, it can be hard to think about the long-term. That's often true when it comes to your finances; whether the crisis is an extended period of joblessness, family illness, divorce or something else, it can force otherwise responsible savers to deplete their cash reserves, take on high-interest debt and delay retirement planning.
After a major setback, the thought of turning your attention to long-term financial goals may seem overwhelming, particularly if you're still coping with debt and other expenses. And to be fair, every crisis is different: A divorce, for example, can entail ongoing costs in a way that a period of unemployment, once it has ended, might not. Even so, once a crisis is over, every month you put off contributing to a tax-advantaged retirement plan means you could potentially be losing out on compounded growth that can help point you toward a secure retirement when you're no longer earning a paycheck. That's why it's vital to begin triage on damaged portfolios as soon as possible, says Bill Hunter, Director of IRA Program Management for Merrill Lynch. "Saving for retirement may not seem as urgent as the crisis you're dealing with, but it's no less important."
Fortunately, there is much you can do to re-engage with your long-term strategy. Here are some steps to consider that could help you decrease debt, restore your cash reserves and see to your long-term security.
- Replenish your emergency fund. It may seem counter-intuitive that the first step, even before paying down debt, would be to replenish your rainy day cushion. But you never know when misfortune will strike again, and you should make sure that you won't have to dig into long-term investments the next time you're faced with an emergency. (Also remember that immediately following a crisis that involves a financial burden, it may be hard to quickly re-establish a line of credit.) "Your emergency fund is a buffer to help keep your long-term savings on track," says Hunter. "When the next crisis happens, you don't want to have to sell securities or incur hefty additional taxes for early withdrawals from retirement plans." The amount you need might vary depending on your circumstances, but aim to squirrel away 6-8 months' worth of expenses in a liquid, interest-bearing savings or money market account.
- Pay down debt. Once your emergency fund is at the four-month level, you can begin to reduce debt while continuing to save at a slower rate, says Hunter. Start by repaying your future self. A record proportion of workers - 27.6% - had 401(k) loans outstanding at the end of last year, according to a 2011 survey by management consulting firm Aon Hewitt. While interest rates on such loans are relatively low, taking that money out of your account could mean losing out on critical compound growth. "You are technically paying yourself interest, but it's still good practice to put that money back to work," says Hunter. Next, tackle high-interest credit card balances or any loan costing you 15% or more. Put off discretionary purchases until you have that pricey debt under control.
- Re-establish your retirement plan contributions. If you can afford it while paying off loans, resume contributions to your 401(k) - especially if your employer offers a company match, which effectively doubles your investment. After that, you can choose to make additional 401(k) contributions or add money to an IRA (which may provide additional investment options). If you're older than age 50, try to take advantage of the catch-up provisions to put away as much as $5,500 more in your 401(k) and an extra $1,000 in a traditional or Roth IRA. "I believe that this is also a time to make sure your portfolio mix is in line with your risk tolerance and has a balanced asset mix of stocks and fixed-income securities, especially if you had to liquidate a portion of your holdings to address the crisis," notes Hunter.
- Once things settle down, look for additional sources of liquidity. After your emergency is over and you've gained some stability, you may want to pursue a line of credit, which should be easier to get now, while your financial situation is solid. Also, take a look at whether you could draw Social Security benefits in an emergency. If you're widowed, you can begin receiving benefits at age 60, and disability payments can start at age 50. You'll get a reduced benefit because you're taking money early, but that may be better than diverting savings from a tax-deferred account. Hunter notes that even if you're divorced, you can still receive spousal Social Security benefits if you were married for at least 10 years.
- Generally speaking, you can also take distributions from a Roth IRA without federal taxes or additional tax assessed with early distributions as long as you withdraw only your contributions and not the investment growth you've earned. Insurance can be another important safety net, says Hunter. "Consider long-term care insurance to avoid catastrophic costs if you're disabled and need care at home or in a nursing facility."
By being aware of your sources of liquidity and creating new ones if needed, you can be generally able to protect your nest egg if a financial crisis hits your household again.
Important questions to consider regarding your financial health:
- Is my current emergency fund sufficient to protect me if there's a crisis involving my personal health or finances?
- Are my savings priorities in line with my goals?
- Could I rearrange my financial holdings to provide more help the next time there's a crisis?
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