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Lining up Your Cash Sources for the Next Emergency

Last update on: Nov 21 2019

One key to a successful retirement is being able to handle the surprises.

You don’t know when the surprises will come or what they will be, but you can bet retirement will have surprises. A sharp market downturn is one possible surprise. A wide range of large, unplanned
expenses also is possible: home repairs, auto repairs or replacement, large medical expenses, help for children or other relatives and more.

What these surprises have in common is that they create a sudden need for cash beyond your regular monthly needs. Or, in the case of a market decline, a source of cash is impaired. A good retirement plan includes several options for coming up with the cash these surprises require.

Of course, you have a nest egg of investments, and some investments could be sold to raise cash. But selling investments often isn’t the most desIRAble move.

When markets are down, you usually don’t want to sell investments. Assuming you don’t think the decline is permanent and you’re a long-term investor, the better strategy is to hold the investments. You don’t want to sell at or near the bottom of a market downturn to raise cash only to see the investments
turn around and recover their losses. That effectively increases your losses and increases the probability you’ll run out of money. There also could be capital gains taxes and trading costs from selling investments to raise cash.

It is best to have other options for dealing with cash emergencies and to have them in place before the urgent cash needs occur. If you’ve been following my advice for a while, you’ve already taken several steps.

Guaranteed income. You should have guaranteed income that covers your basic, fixed expenses. Guaranteed income includes Social Security and annuities (either immediate annuities or deferred income annuities). Some people also will have a pension and perhaps another source of two of guaranteed lifetime income. Guaranteed income doesn’t raise additional cash. But it ensures your basic, continuing living expenses are covered regardless of what happens in the markets. That reduces
stress and might decrease the amount of cash you have to raise. It also can let you focus first on reducing some discretionary spending for a while to raise cash.

The safety fund. Another good strategy is to set aside in safe investments enough money to cover expenses for two to five years that won’t be covered by the guaranteed income. Knowing this money is in safe investments, such as money market funds and certificates of deposit, also reduces stress in tough times, especially when markets tank. It means you won’t be forced to sell investments to cover regular,
planned spending. It also means you can tap the emergency fund to pay for a surprise. That gives you time to look for options to replenish the emergency fund or to wait for markets to recover.

Risk management. While some people manage their nest eggs to maximize gains, I think retirees should focus on managing risk. Determine which risks are in your portfolio and reduce or eliminate those you don’t want to take. That might mean reducing your stock allocation, even during a bull market
that seems to have no end in sight. It also might mean holding investments that are lagging now, because risk management over the long term means you should have a diversified, balanced
portfolio. At a minimum, know the maximum percentage of your nest egg that you want in stocks and other risky assets, and be sure not to exceed that level.

Having insurance is another way of managing risk. The insurance increases your regular fixed expenses. But insurance means your maximum exposure to most emergencies is limited. If you have traditional Medicare, you should seriously consider also having a Medicare supplement policy and Part D prescription drug coverage. These are the two insurance policies every retiree should consider. Those in Medicare Advantage plans already have this coverage built in.

Flexible spending. The more fixed expenses you have, the less you’re able to adapt at a tough time. That’s especially true if there’s very little difference between your guaranteed or reliable income and fixed spending.

Most retirees can find a fair amount of flexibility in their spending plans. They can eliminate, reduce or delay expenses such as traveling, spoiling the grandchildren, dining out, entertaining and more. In your spending plan, put expenses into categories such as required, nice to have and aspirational. Periodically review the plan to identify aspirational and nice-to-have expenses.

Temporary borrowing. You should have borrowing sources lined up to tap in a pinch. I generally don’t favor long-term borrowing in retirement (see our June 2018 issue), but sometimes it’s better to borrow short-term to avoid selling investments. You can pay back the loan over time either from other
income or by selling the investments after they recover.

Borrowing is not as easy for retirees, because they don’t have steady paychecks. It is a good idea to have your borrowing power locked in early in retirement to ensure it’s in place.

Often the best borrowing source in retirement is the reverse mortgage line of credit, also known as the home equity conversion line of credit. You don’t have to pay back any money you borrow against the line of credit as long as you live in the home. I discussed these in detail in the February 2018 edition of my online seminars, the Retirement Watch Spotlight Series and in the November 2015 issue of Retirement

You also can take out a traditional home equity line of credit. The disadvantage of these loans is you have to begin paying at least interest on the loan immediately. The interest rate also tends to be variable, so the payments can increase if interest rates are rising.

Your investment portfolio also might be a borrowing source. Most brokers allow clients to take margin loans against their portfolios. The interest rate usually is very low. Your investment portfolio is your collateral for the loan. That limits the amount you can borrow. It also means that if your portfolio declines in value, the broker might sell some assets to pay part of the loan. That’s why it’s not a loan you want to maximize.

Note: Don’t set up a margin loan with an IRA. That could be considered a prohibited transaction and cause the entire IRA to be taxable.

Finally, permanent life insurance also is a good source of cash. Most policies allow owners to borrow against the cash value accounts. The loans often don’t have to be paid back. Instead, the loan principal and accumulated interest reduces the amount eventually paid to beneficiaries. The loans are tax free.
You can take distributions from the cash value account instead of loans, but distributions usually are taxable.



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