A Financial To-Do List for May

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Morningstar's director of personal finance Christine Benz has created a month-by-month financial to-do list for 2021. She is here today to discuss what should be on that list for May.

Hi, Christine. Thanks for joining us today.

Christine Benz: Hi, Susan. It's great to be here.

Dziubinski: For some of us, May is going to be a little bit more hectic than we might have originally expected because the tax-filing deadline for 2020 has been pushed back from April 15 to May 17. What should we be keeping in mind with that?

Benz: It gives us all a little bit of extra time to prepare our returns. I think the IRS has been deluged itself. And so, it decided that with all of the chaos related to the pandemic that it wanted to give people this extension to get their tax information in order. One of the key things to know about this, Susan, though, is that people who are paying quarterly estimated taxes still needed to have those estimated tax payments in by April 15. And most of the states require, if you're paying to your state those quarterly estimated taxes, you would be required to have those funds in by April 15. So, check with your state treasurer's office to see what the rules are. In most other respects, though, state income taxes are on that May 17 deadline as well.

I also want to point out that May 17 is the deadline for making those last-minute, HSA, health savings account, and IRA contributions for the 2020 tax year. So, you're really bringing it down to the wire, but you do have until May 17.

Dziubinski: On your original to-do list for May was emergency funding. And a lot of people think that emergency funding is just something that people who are just starting out need to think about. But that's not really the case, right?

Benz: It's not at all. In fact, Pew Research released this report back in 2020 looking at emergency fundedness and found that this problem really cuts across income bands. Naturally, people with lower incomes do have a hard time amassing emergency funds. So, about three fourths of people at lower income levels said they didn't have three months' worth of living expenses on hand. But about half of middle-income folks said they did not have three months of living expenses and about a fourth of higher-income people did not have that three months' worth of living expenses. I think sometimes people confuse the fact that they have high incomes with the fact that they have a buffer. So, I think it does really underscore the importance of making sure that your cash reserves are up to an appropriate size no matter what your income level. Three to six months would be the absolute minimum, but higher-income folks would want to set their target higher.

Dziubinski: How much is enough in an emergency fund? So, you say three to six months. So, if you are a higher-income earner, what should you be thinking about?

Benz: That's a good starting point. But I do think that you want to think about if you were to experience unexpected job loss, how long it might take you to replace that job. We know that people with higher incomes are often in more specialized career paths. Those positions can take longer to replace. Higher-income jobs in general can take longer to replace. So, I like the idea of setting the target higher. Closer to a year's worth of living expenses if you're a higher-income earner. I always say that if you're the sole earner in a family, that also argues for having an even bigger cushion because you don't have another person's income to fall back on if you were to lose your job. Older adults, I think, too, should probably set their targets higher because it often takes them longer to replace jobs that they've lost, and they might also fall into that category of higher income and/or more specialized career paths, jobs that we know take longer to replace.

Dziubinski: Christine, where do you suggest that people invest those emergency dollars?

Benz: Well, I would keep them very liquid. So, you'd probably want to use some sort of a cash account. You have to settle for really, really low yields today, but the idea is that you wouldn't want to have the money invested in anything where you might incur a loss if you needed to get your money out. A separate question but related, Susan, is this idea of which account type to use. And generally speaking, I would say people should use taxable accounts, so nonretirement accounts for their emergency savings. So, those would be accounts where they could get their money out without any strings attached where you wouldn't pay taxes or penalties.

The one exception would be a Roth IRA. And I sometimes think that this is a good idea for people just getting their plans off the ground, younger people who are sort of conflicted about whether to build an emergency fund or save for retirement. Well, a Roth IRA in a lot of ways lets you do both in that you can put the money in and ideally let it grow all the way until retirement. But if you need your money out prematurely for some nonretirement expense, you can get those contributions out without any taxes or penalties for any reason. Just the contributions, not the investment earnings. But that's a really nice escape hatch and gives the Roth IRA a nice sort of level of multifunctionality.

Dziubinski: Christine, you also think it's important to develop a broader contingency plan for financial emergencies. What do you mean by that?

Benz: Well, I think it's worthwhile to think beyond just having the emergency fund in place but also think about a broader contingency plan in case you lost your job. So, you'd want to think about how you can skinny down your budget, what items you might cut out of your budget if you had some sort of an income disruption. Think through healthcare coverage. If you have employer provided healthcare coverage, what would your plan B be in case you lost that position and needed to get healthcare coverage elsewhere. And then, I think also it's worthwhile for all of us regardless of life stage just to think about backup career planning. Is there something that's sort of adjacent to our current job that we may be able to do to continue to earn income while we're looking for a full-time replacement job? So, that might be some type of consulting in your field. You may be able to earn some sort of part-time income to keep you going. So, just to think through all of the other aspects of job loss just in case that you were to experience some sort of unexpected income disruption.

Dziubinski: Let's talk a little bit about retirees. Do retirees need emergency funds?

Benz: This is controversial, but I would say yes in part because even though job loss isn't an issue when you're retired and you may have mapped out all of your regular ongoing expenses, there are still unexpected expenses that crop up in retirement, whether car repair bills or vet bills or big home repair bills. So, think through those and set aside assets to cover you so that you are not needing to invade your long-term portfolio to cover some of those unexpected expenses if they should crop up, and they inevitably will.

Dziubinski: And lastly, one other thing on your May to-do list, specifically for retirees, is for them to check their cash reserves. So, what should the cash reserves look like and how does that relate with the emergency fund?

Benz: It's related for sure. But Susan, you know I'm a big fan of the bucket approach to retirement portfolio planning. And part and parcel of the bucket approach is having liquid reserves set aside to cover you for one to two years' worth of portfolio withdrawals. And the idea there is that you do have those liquid reserves so you wouldn't need to touch your long-term portfolio. And I think the other side benefit of having those liquid reserves is that it provides peace of mind. We know that the markets encounter periods of volatility. Bonds have even undergone a little bit of turbulence so far in 2021. So, the idea is that if you have those liquid reserves set aside, you can really be able to put up with the volatility that is likely to accompany your long-term portfolio. It's just important to remember don't overdo this piece of your portfolio because returns, as we all know, on cash investments are really, really low today.

Dziubinski: Well, Christine, thank you so much for giving us our marching orders for May. We appreciate your time and we'll talk to you again this time next month about what we should be thinking about for June. Thanks again.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.