Lining Up Your Cash Sources for the Next Emergency

Many people found they lacked a safe, reliable source of cash in March when investors became concerned about the coronavirus pandemic. Markets were falling. Businesses were closing.

A credit crunch was spreading through the markets and the economy. The only option for many people was to raise the cash they needed to pay expenses by selling assets at prices that turned out to be artificially and temporarily low.

It is rarely a good idea to sell during a panic, but many people had little choice.One key to a successful retirement, or any financial plan, is being able to handle the surprises.

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

What these surprises have in common is that they create a sudden need for cash above your regular monthly expenses. 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. 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, as happened soon after the market lows in March. That effectively increases your losses and increases the probability you’ll run out of money during retirement. 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.

Guaranteed income. In retirement, you should have guaranteed lifetime income that covers your basic, fixed expenses. Guaranteed lifetime income includes Social Security and annuities (either immediate annuities or deferred income annuities).

Some people also will have a pension and perhaps another source or 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 is happening in the markets and elsewhere. That reduces stress and should decrease the amount of cash you have to raise.

It also can let you focus first on reducing some discretionary spending for a while.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 treasury bills, 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 to cover some surprise expenses is another way of managing risk.

The insurance premiums increase your regular fixed expenses. But insurance means your maximum exposure to most emergencies is limited. If you have Original Medicare, for example, you should seriously consider also having a Medicare supplement policy and Part D prescription drug coverage.

Or, you can join a Medicare Advantage plan instead of having original Medicare. Either strategy cushions you from having to pay a lot of money for surprise medical expenses.

Flexible spending. The more fixed expenses you have, the less you’re able to adjust during tough times. That’s especially true if there’s a large gap between your guaranteed or reliable income and fixed spending.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.

By having these categories deter-mined ahead of time, you know where to look when expense reduction is needed. You can eliminate, reduce or delay expenses such as traveling, spoiling the grandchildren, dining out, entertaining and more.

Temporary borrowing. Yo u should have borrowing sources lined up to tap in a pinch. I generally don’t favor long-term borrowing in retirement, 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 pay-checks. It is a good idea to have your borrowing power locked in early in retirement to ensure it is available

.Often the best borrowing source in retirement is the reverse mortgage line of credit, also known as the home equity conversion mortgage 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.

You also can take out a traditional home equity line of credit. The disadvantage is you have to begin paying at least interest on the loan immediately after you borrow. 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 the 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 you want to borrow against only a portion of your portfolio.

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 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.