By Skyler Kraemer MS, CFP®
Right now millions of Americans are out of work. In what feels like a blink of an eye, many people went from happily working, to not having any form of income. While income may have gone away, the bills almost certainly haven’t.
This article is designed to help you figure out the smartest way to withdraw funds if they are needed during the coronavirus (COVID-19) global pandemic.
1. Emergency Reserves
The first place you should be spending from is your emergency cash reserve. One of the first lessons you learn as a financial planner is that you should always have 3-6 months of known, non-discretionary, cash flows in checking/savings accounts as an emergency reserve. This Pandemic is exactly why we recommend this. If you have one, congratulations and feel free to use it because this type of event is exactly what it was for. If you did not have one, you should remember this moment for the rest of your life. And you should use this moment to teach your children and grandchildren of the importance of having one.
2. After-Tax Brokerage Accounts
This includes individual accounts, joint accounts, and Trusts. This is your second line of defense. The important caveat here is that if possible, you should try to avoid selling stocks (and stock funds/ETFs) since they are still depressed and selling them now may be locking in those losses. Time periods like this are exactly why you should almost always have at least some percentage of your investment portfolio allocated to lower risk investments like core fixed-income.
3. Tax-Deferred Retirement Accounts
These include employer sponsored 401ks, and IRAs. The recently passed CARES act has certain provisions that allow you to tap into retirement accounts. For people under the age of 59.5 it waives the 10% penalty typically charged for early withdrawals. You may also not owe taxes on withdrawals if you put the money back into the accounts within three years. If not the withdrawals may be taxed as ordinary income. Because time is the most important factor in the magic that it is tax-deferred growth and compound interest, if possible you should try to avoid using these types of accounts. You should also only use them to the extent that you’ve draw down on the accounts listed above. The same caveat about selling stocks in taxable accounts also applies here.
4. Enable margin on your taxable accounts
Margin is essentially a negative cash balance in your brokerage account. In a way it is like taking a loan from the custodian that holds your investment accounts (like Fidelity or Schwab) with those investments as collateral. You pay interest on the amount you withdraw and eventually you should pay it back. The amount of interest you are charged is typically tied to the Prime Rate which is right now is 3.25%. To give context, the historical average Prime Rate is closer to 7%. This means that interest on margin loans are less than 1/2 what they usually are. When you work with an Advisor (like Mission Wealth) you may also get a discount on the margin rate custodians offer to their retail clients.
A few things to know/be aware of. There is no such thing as margin in a tax-deferred account like an IRA. How much you can withdraw will depend on the value of the account which will go up and down with the market. If the value in your account goes down dramatically you may be faced with something called a margin call, where your custodian/broker requires you to pay back some or all of the loan you took. Due to the risk of getting a margin call I would not recommend this for anyone who is not working with a professional to manage their investments.
5. Home Equity
You could tap into the equity in your home. For many of us our homes are our most valuable asset. There are a few ways you can do this.
- You could do a cash-out re-finance of your mortgage. The mortgage industry has been under a lot of strain recently due to a flood of re-finance applications so doing this quickly may be challenging. When you do a cash out re-finance you also typically pay a slightly higher rate than for a non-cash out re-finance. The good news is that while mortgage rates are going up and down quite a bit they are still within a very low range when compared to historical averages.
- You could open a Home Equity Line of Credit (HELOC). There is a saying that goes "you should apply for credit when you don't need it, because when you do need it, the banks won't want to give it to you." This is most certainly true for HELOCs. A HELOC is an open line of credit against the equity in your home. The difference with a HELOC is that both the interest rate and loan amount are variable. Over time you can pull funds out against your HELOC as needed. Over time the interest rate will also go up and down. The good news is that HELOCs are also tied to Prime and rates are fairly low right now. With the mortgage industry struggling to keep up with demand this may be the quickest option. Something you may consider doing is opening a HELOC to draw funds in the short-term, then in a few months, doing a cash out re-finance and using the proceeds to pay off the HELOC. Here a few great resources on HELOCs:
- You could do something called a reverse mortgage. In order to qualify for this you need to be a certain age but this allows you to withdraw a fixed monthly amount, take out a lump-sum, have an open line of credit, or some combination of all three. With a reverse mortgage, you never have to pay the loan back. When you pass away, some or all of the proceeds from the sale of your primary residence are used to pay back the loan. The best part is that even though you are charged interest on the loan, the amount your estate owes can never go above the value of your home when you pass away. Reverse mortgages may be great resources for retirees who have been too aggressive in their investment accounts, need to withdraw funds now, but want to give their investments time to recover. The biggest downside of a reverse mortgage are that there can be some high fees associated with originating the loan.
6. Credit Cards
The one thing you want to try to avoid doing is putting all of your bills on high-interest credit cards. This could lead to a quick-sand like trap, where the interest on your loans, which for some cards can be as high as 25%!, is more than you can afford to pay off each. If that happens you’ll never get out of debt.
For some people, if you don’t have an emergency reserve, have after-tax or tax-deferred investment accounts, or own a home, this may be your only option. If that is the case, you should make sure you are being smart about this. You may want to consider applying for a new credit card with a one year 0% introductory interest rate. No matter what you should always be aware of the interest rate on all of your debts and create a plan to determine how you are going to pay down your debt once you get your income back.
In conclusion, you have options.
We are faced with unprecedented times. For millions of people across the world COVID-19 has wiped out their income and they are struggling to figure out how to make ends meet. You can think of this article as an order of operations for where to take withdrawals from to pay your bills.
With that being said, making decisions about complex financial issues like using margin or taking a reverse mortgage, should not be done lightly. All aspects of your financial plan should be take into consideration include a deep dive analysis of your balance sheet and cash flows.
If you’re a client of Mission Wealth, reach out to your advisor and they can provide guidance on all of these topics. If you’re not a client and have questions about this, please reach out to us using the contact form below.