What To Do When Your Rainy Day Fund Runs Dry

Millions of out-of-work Americans are currently struggling to pay their bills, whether it be day-to-day expenses or large, unexpected emergency outlays. As I queried in a recent blog, what happens to folks without rainy day funds who suffer grave financial setback?

In the case of the COVID-19 pandemic, Uncle Sam has offered near-term rescue packages of one sort or another. But because the pandemic keeps hanging around, many folks and small companies still remain short of funds. Then what? Who do they turn to? Often people do things out of desperation that exacerbate their financial woes… such as borrowing from retirement accounts, which disrupt carefully laid plans designed to meet long-term financial goals. Let’s explore some options for folks who find themselves in short-term financial straits.

Family Assistance

Younger, perhaps single folks often turn to parents or other family members for help. If parents are not themselves experiencing financial difficulties, it’s a sensible option… one without tax ramifications. If it’s a loan, it’s probably one with flexible repayment possibilities. More financially secure parents might even considered offering a gift to help out. But if parents themselves later become cash-strapped and apply for Medicaid, such earlier gifts or loans might need to be repaid if they fall within certain time constraints. Both parents and recipients need to keep such possibilities in mind.

Short-Term Funds

Hopefully, folks who’ve had the foresight to accumulate Rainy Day Funds did so in a manner that allows quick access to the money without penalty. Certificates of deposit often have early withdrawal penalties, and some savings and money market accounts have restrictions on withdrawals per month. Wise pre-planning can avoid such restrictions or penalties.

529 Plans

529 education savings plans are commonplace in American life, and are important tax-deferred plans by which parents save money for their children’s education. Should an unexpected financial crisis develop, families can tap into such resources – with the obvious caveat that they will lose out on tax-deferred growth. Additionally, the earnings portion of such a distribution (for non-education purposes) becomes subject not just to ordinary income tax, but in most instances, to a 10% penalty as well.

Credit Cards

The least desirable source of cash is a credit card. Cards charge extremely high interest rates and borrowing can hurt an individual’s credit score… not a desirable event when cash is short in the first place. However, for folks in desperate straits, credit card borrowing might be a viable option because down the road a negotiated settlement might be possible. But don’t count on it.

Life Insurance Policies

The cash value of permanent life insurance policies can be a source for quick cash. After all, it is your money. And a cash value withdrawal – up to your policy basis (the amount of premiums you’ve paid into the policy) – is typically non-taxable. Amounts over the policy basis are taxed as ordinary income. And expect surrender charges. The amount of cash value available depends on the type of policy you own and the company issuing it.

If you have a sizable cash value built up in your policy, you can choose to take out a loan, often at interest rates lower than traditional bank loans. And there is no obligation to pay back the loan since it’s your money. However, any money you borrow and don’t pay back (plus interest) will be deducted from the policy’s death benefit upon your untimely demise. As a reminder, permanent life insurance policies offer both a cash value amount and a death benefit. If a policy owner doesn’t claim the cash value portion prior to death, beneficiaries only receive the death benefit. Any remaining cash value goes back to the insurance company. Policy owners should keep this in mind. Again, it’s your money.

Home Equity Loans & Lines Of Credit

Regarding home equity lines of credit, borrowers can withdraw funds as needed up to a certain amount, often at attractive floating rates of interest with generous payback terms. A home equity loan is a lump sum with a fixed rate of interest among other terms. But never forget, your home is the collateral to such a loan and is at risk if the loan is not repaid. By the way, if the loan is to help fund education expenses, any unspent proceeds are counted as family assets on a Free Application for Federal Student aid (FAFSA).

Social Security

Folks who’ve reached full retirement age and have not yet begun collecting benefits can request a lump-sum distribution of six months of benefits at once. However, there’s a big catch. By doing this, you may be giving up an even bigger retirement check from Social Security for the rest of your life. In short, the monthly benefit will decrease to what you would have received had you applied for benefits six months earlier. This source of quick cash just might be a bridge too far.

Retirement Accounts

Then there are those valuable retirement accounts. I often preach that a healthy Rainy Day Fund is critical to avoiding raids on retirement accounts. Such disruptions can have long-lasting impacts on the quality of life in retirement. However, the ability to access retirement accounts can play an important role in a family being able to handle big expenditures like higher education expenses, a down payment on a home and unexpected medical expenses such as pandemic-related adversities. As most folks know, the recent CARES Act offers pandemic-related victims additional flexibility to access IRA or workplace-related retirement plans. But recall that you pay taxes on withdrawals from tax-deferred plans, which are recoverable if the distribution is paid back within three years (be aware of the tax ramifications if a loan isn’t paid back according to the loan’s terms). Here I go again, but I would caution folks who must raid their retirement accounts to take only the minimum amount needed… not necessarily the maximum available. You’ll thank yourself later.

Fund Your Fund

This list of quick cash sources is not all-inclusive, and each individual arena of financial assistance involves additional unlisted details. But it’s nice to know in times of financial stress that certain options exist to alleviate immediate problems. Bottom line: If you don’t already have a Rainy Day Fund, start accumulating one and then complications associated with the foregoing options won’t matter.