While financial advisers generally help their clients by primarily focusing on long-term financial goals and planning, everyone can experience a short-term cash crunch. Advisers have several options for helping, with the best solutions depending upon their situation.
Short-term cash needs could arise for any number of reasons. These might include an unexpected repair to a client’s car or their home. It might arise from a job loss or a temporary furlough, the latter has become all too common in 2020 in the wake of the COVID-19 pandemic. It might arise due to a medical issue for the client or one of their family members.
Here are some options to consider.
Ideally over the years your client has been able to set aside money in an emergency fund. Assuming this money has been kept in a liquid account like a money market fund or a savings account. This money should be available to them by writing a check or perhaps via a transfer to their regular checking account. A general rule-of-thumb is that folks should have at least three to six months worth of expenses tucked away in their emergency fund.
Once the situation that caused the short-term cash crunch has passed, clients should be encouraged to replenish their emergency fund as soon as they can, even if this is a gradual process.
Depending upon the nature of the client’s situation, using a credit card to help with some or all of their expenses can be a solution. It's an easy and convenient way to cover expenses.
The downside comes when a client’s cash needs are caused by a situation that will reduce or eliminate their income for a period of time. This can result in their not being able to pay the balance off in a timely fashion and being subject to increased costs if the interest rate on the credit card is high. This type of situation could also hurt their credit score, causing adverse financial ramifications long after their cash crunch has subsided.
Personal Lines of Credit
Clients with solid credit histories may be able to open personal lines of credit (LOC) with their bank or another financial institution. These are typically unsecured, though in some cases and with some institutions, there may be options for a secured line of credit as well.
If the client has an open LOC, tapping it might be an option for their short-term cash need. Depending upon the nature of their situation, they may or may not be able to open a LOC to help deal with the cash needs if they don’t have one.
These lines of credit can be ideal for funding an unexpected large purchase or funding an emergency expense.
A LOC is generally an open line of credit up to a set amount that expires at a specified date. The interest rate generally is variable.
Tapping Retirement Accounts
The CARES Act eased some of the rules around tapping into retirement accounts early in the wake of the COVID-19 situation.
For those impacted by the pandemic, the CARES Act allows the withdrawal of up to $100,000 from a 401(k) or an IRA without incurring the normal 10% penalty if they are under age 59½.
To qualify for this relief, clients would need to show:
- That they, their spouse or a dependent was diagnosed with COVID-19 or,
- They have suffered some sort of financial hardship from COVID-19 such as a job loss, a furlough, reduced hours, etc.
The distribution will still be taxable, but those taxes can be spread out over three calendar years. Additionally there is the ability to “recontribute” those funds, putting them back into the account to avoid some or all of the taxes on the distribution.
The CARES Act also increased the amount available via a 401(k) loan to the lessor of $100,000 or 10% of the participant’s balance. This is double the normal limits. Technically a participant must be impacted by COVID-19, but this is based on self-reporting.
For both the distribution and loan provisions, retirement plan sponsors must adopt these measures. Both provisions are for 2020 only at this point.
Working with your client to decide whether either of these options is the right one for their short-term cash needs. While a 401(k) or an IRA might typically be a major source of funds for your client, the implications of taking a loan or distribution from their account should be considered and discussed with your client prior to going this route.
These include reducing the client’s ability to retire when they had planned and to accumulate the amount needed for a comfortable retirement. This needs to be weighed against the amount of the client’s cash shortfall and the urgency of their situation.
Sell Taxable Investments
If the client has investments in a taxable account, selling some of these holdings to raise the cash needed might be an option. This is another option that potentially takes assets meant for the long-term and converts them to cash to meet this short-term need. There may also be tax implications if the securities being sold have embedded capital gains. If possible and practical based on the client’s situation, tax implications should be considered so as to not saddle your client with a large tax bill next filing season. This is a good place to consider tax-loss harvesting if possible.