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Where to Get Cash in a Crunch

Maria Bruno discusses options from the old and familiar to the new and temporary.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Christine Benz: Hi, I'm Christine Benz from Morningstar. Amid the pandemic and its related economic effects, some individuals may find themselves in a cash crunch. Joining me to discuss some strategies to consider if you're in this predicament is Maria Bruno. She's head of U.S. Wealth Planning Research at Vanguard, and she's also a Certified Financial Planner. Maria, thank you so much for being here.

Maria Bruno: Thanks for having me, Christine.

Benz: Maria, we always counsel people to have that emergency fund in place. Some people may have exhausted their emergency funds if they faced unemployment through this period, but that really is the gold standard, right?

Bruno: Yeah, absolutely. I mean, we talk about emergency savings a lot, and I think a lot of individuals are kind of going through that crunch right now. So we talk about the rainy day fund, an emergency savings fund of typically three to six months' worth of living expenses in some type of cash account. I think that's a good starting point. I don't think it's for everyone. What we often suggest, and we've written some research around this, is really to rethink emergency savings. And by that, I mean, think about it in terms of spending shocks versus income shocks. 

Spending shocks tend to be those things that--maybe something goes on the house or the car. It's an unexpected expense that you need to make sure that you have ample funds for. We usually give a guideline of having about a half-month worth of expenses, maybe up to three months, in a cash-type account. By that, I mean either a bank checking account, savings account, or like a money market mutual fund, where you can have quick access to that. 

Beyond that, you may want to think about an income shock, which is exactly having some type of loss of job and the impact there. And now you maybe want to think about other types of vehicles. One of the things I like to talk about is if you have a Roth IRA, you can access the contributions income-tax-free and penalty-free. You've talked about this as well, a multitasking type account. So it's a retirement account but yet does have a liquidity feature that is there in the event that you would want to use that. Another thing to consider will be health savings accounts. If you have medical care expenses, if you have money in those accounts, those are there to meet those expenses. Ideally, if you can pay out of pocket, that's the best thing to do because then the account continues to grow tax-advantaged, but health savings accounts obviously are one way to meet healthcare expenses. And then the other thing I would add there is brokerage type accounts. So if you have nonretirement accounts, think of those as well, but be mindful if you need to tap those to be as tax-efficient as you can be when you go and make any transactions. Maybe look for any types of losses or try to minimize gains on those types of accounts.

Benz: Let's discuss the CARES Act with respect to emergency funding needs. It did open up some additional opportunities for people who want to potentially tap into their retirement assets. Let's talk about those withdrawals that might be available. Shouldn't be a first-line defense but might be available for some people.

Bruno: Right. So they did provide some relief for individuals who are impacted by the coronavirus. So they're able to access their employer-sponsored plan or their IRA up to $100,000. So, pre-59 1/2, if you tapped these proceeds, you were subject to a 10% early withdrawal penalty. That's been waived, and you can take the distribution up to $100,000. And then you also have the option to spread out the tax liability over three years. It's important to note that the early withdrawal penalty has been waived, but the actual taxation with the distribution still holds, but they allow the taxes to be paid over three years, so that is one option.

I will note with that, too, is if you take the monies out and you return it within that period, then you wouldn't necessarily have to pay the taxes. So, there is some flexibility there if you're in a pinch to access that type of funding. The other thing that was part of the CARES Act was the ability and a little bit of an expansion on 401(k) loans. So now the limit is up to--it's the lesser of $100,000 or your vested balance--and you have up to five years to repay that loan. Those are two of the expansions on the ability to access retirement accounts.

Benz: That's what you can do under the CARES Act. I guess the question people might be grappling with is: Should I do this? Can you address that?

Bruno: That's a good question. Just because the option is there, whether you should take advantage of it or not is highly individualized. So I would probably suggest stop and thinking through this a bit, too, just to make sure that you understand the implications of that. If you do pull from your retirement accounts, particularly if you're taking a withdrawal, you're subjecting the withdrawal to income taxes. So that's another liability there as well, but you're also taking the distribution from the retirement account and forgoing compounding all of those dollars. So it may not seem like a lot.

A simple example, you could take a $10,000 withdrawal from a 401(k), for instance, and you assume, hypothetically, a 6% annual return. Over 30 years, that comes to $57,000. So what seems like a small amount of money today, the loss of compounding actually has greater impact over time. I would suggest a couple of considerations there before tapping those monies to see whether or not you have other liquid assets or other accounts like Roth contributions that you might want to consider tapping before tapping the 401(k). That said, if you're weighing those types of distributions against high interest credit cards, you might want to look at that type of option as opposed to incurring additional debt with high consumer interest rates.

Benz: You mentioned HSA assets, Maria, and you mentioned kind of the thesis where if someone has healthcare expenses, those are great assets to tap on ongoing basis if you need them to defray those healthcare costs. How about the HSA? If you have been using it as kind of a savings vehicle and you have other nonmedical expenses, there's some flexibility there, right?

Benz: Yeah. It's interesting. There's many benefits to health savings accounts, you've talked and written about this as well in terms of the tax benefits. And there's lots of flexibility with these types of accounts. So you can really treat them as a retirement vehicle and, depending upon the investment options, invest accordingly. If you're in a good position where you have the financial means to pay healthcare expenses out of pocket when you incur those and let the HSA grow deferred, that's terrific. 

What you can also do is if you do incur those healthcare costs, sometimes we call it "shoe-boxing receipts," where you then can go back, and if you have these receipts, you can match them up to the HSA. And then you withdraw from those accounts later. And obviously, you're not using it to fund that specific healthcare cost because you incurred that potentially years before. So I guess the point there is that the healthcare cost doesn't necessarily have to be incurred in that year. There's not necessarily a matching, but you can actually pay out of pocket. And then later, if you would want to then go back and use that receipt and to pull from the HSA essentially, you have that flexibility.

Benz: Maria. Big topic, lots of people grappling with some of these considerations. Thank you so much for being here today to provide your insights.

Benz: Thank you, Christine.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.