President Trump has decided to call a temporary, three-week cease fire in his battle with Congress over a wall, which will certainly come as some relief to the hundreds of thousands of Americans -- federal workers, contractors, and others -- who weren't paid during the 35 days of the government shutdown. And beyond those directly impacted, millions more took hits to their income from the knock-on effects. Overall, there were a whole lot of people in a whole lot of money trouble. All of which is a darn good reminder that no matter who you work for, you need to have an emergency fund. Maybe you have one, maybe you don't.
In this segment from the Motley Fool Answers podcast -- recorded before we had any idea how much longer the shutdown would last -- hosts Alison Southwick and Robert Brokamp discuss the pros and cons of various options available to individuals and families after they've run their regular bank accounts dry. Some of them assume you have other assets. Some don't. But hopefully, if you ever need such tips, one or more will prove helpful.
A full transcript follows the video.
This video was recorded on Jan. 22, 2019.
Robert Brokamp: What should you do once it's gone? What if you don't have any more cash in the bank? I'm going to lay out a few options and give the pros and cons, and depending on your situation, one might be better than the other.
The first one is to sell investments in regular taxable accounts. If you have a regular brokerage account and you own stocks, just sell those. The pros are it's pretty easy and pretty liquid. You'll get the cash pretty soon. The market is down somewhat. Maybe it's a good time to do some tax loss harvesting. You can sell a stock that is less than what you paid for it and wait 30 days to buy it back. If you don't have the money, don't buy it back, but at least that will reduce your tax bill this year. That's a pro. It's pretty easy to get that money.
The con is ideally you bought that investment as a long-term investment and now you're going to have to sell it. The market is down and that's one of the reasons why you want an emergency fund -- you're not forced to sell stocks when they're down. Plus, if you are selling at a gain you're going to owe taxes in a year. If you sell an investment with a big capital gain, make sure you have a plan for paying those taxes. You don't want to forget about it and then be surprised come April 15th, 2020.
Another option, of course, is credit cards. Credit cards are easy because everyone takes them and if you are a federal employee and you do expect to get your money back (they just passed a bill that says once people do go back to work they will get their pay), a credit card is a good source of short-term money. You just have to make sure you pay the bill. Maybe get some points for airline miles.
The cons are of all the debt you could owe, this has got the higher interest rate. In December of last year the Fed raised interest rates. Despite that, rates across the board in everything from Treasurys to mortgages went down with one exception: credit cards. Credit card rates went up and they're now at all-time highs, according to CreditCards.com.
Alison Southwick: Really?
Brokamp: Yes, at least as long as they've been tracking it. That's obviously the reason you want to avoid credit cards. It is a short-term bridge, but it is not a long-term solution.
Another option is home equity, and for most people that's a home equity line of credit. The pro is if you've got the equity you probably can get it. There's some setup costs, a credit check, and things like that, but it's usually not a big deal. The interest rate will be much lower than what you pay on a credit card.
The con is you're using your house as collateral, which is always a tricky thing. Also, due to the new tax law that was passed a year ago, the interest on a home equity loan is no longer deductible unless you use it to improve your house. If you're using it to cover short-term bills, that interest is no longer deductible. I'm not a big fan of home equity lines of credit, but it's available.
Another option is to borrow from your employer-sponsored retirement account -- your 401(k), your 403(b), or in the case of federal employees, the thrift savings plan known as the TSP. The pros are that it's pretty easy. Even though it's called a loan, you're really just getting your own money, so there's no credit check. You don't have to get a credit approval.
Southwick: Rick and I know all about a 401(k) loan.
Brokamp: So you know how easy it is.
Southwick: It was so easy that when I asked Rick about any aspect of the process, he was like, "I don't remember. It must have been really easy because I don't remember."
Brokamp: It is easy. You're paying the interest to yourself and not to a bank. Those are the pros. The most you can borrow is $50,000 or half of your vested balance, whichever is less.
The cons are that money gets taken out of the market, so if the market takes off in the course of this loan you'll miss out on that. Also, if you don't pay off the loan, it's considered a distribution and you'll pay taxes and penalties if you're not 59 1/2. Generally you have five years to do it. Again, it's a fine short-term solution, but you have to have a plan to pay it back because if you don't, not only will you pay the tax and the penalties, but you're going to miss out on the future growth of what that money could have provided you if it were left alone in your 401(k).
I should say there recently was a bill proposed to make it easier for federal employees to access the money in their TSP. I haven't followed the details, yet, but know that that's also on the horizon for you folks.
Another option is your other retirement accounts like an IRA. You can always access that money anytime. Interestingly, if you take that money out and get it back in within 60 days, it's like you never did anything. While you legally cannot borrow money from an IRA, people refer to this as the "IRA loan." Take it out. You've just got to make sure you get it back within 60 days.
Just a note of caution. This is considered a rollover and there are some rules about rollovers, including a limit to only one every 12 months. So if you've already done it once and you try it again, it's considered a distribution. You won't be able to put the money back in the IRA and you may owe taxes and penalties. Make sure you learn all about the ins and outs before trying this strategy.
If you're taking money out of a Roth IRA and you don't get the money back in, the contribution you put in will still be tax- and penalty-free. It's any growth you took out on which you'll pay taxes and penalties if you're not 59 1/2. A traditional IRA -- if you take it out and don't get it back in you're going to pay taxes and penalties. The negative there is the same as the 401(k): If you don't pay it back you'll miss out on all that growth and your retirement will be compromised.
Southwick: Or maybe the stock market tanks.
Brokamp: That's true.
Southwick: Some people might time it very well, so let's try to look on the bright side.
Brokamp: That's right. Someone in this studio, in fact. My last option is to borrow from family and friends. If you are in a family where that's fine, it's not embarrassing, and it won't cause any friction with folks, it's a perfectly good solution. When I bought my first house it involved borrowing money from my dad who, in the end, said, "You know what? Don't pay it back. You just won't inherit as much when I eventually die." I was happy with that. That's a great option if you can do it.
The cons of it are it can cause troubles.
Southwick: Borrowing money always can be difficult with family in keeping things fair.
Brokamp: And if you're not in a position of being able to pay it back, that causes problems.
Southwick: Is that Bro's last resort?
Brokamp: It depends. If you have a family where people are well off and have established, "If you're ever in trouble I'm here to help you out," I think that's the first resort. It's probably an interest-free loan and you don't have to go through all the other hassles.
Southwick: No paperwork.
Brokamp: It just depends on your situation.
There you have it. Building an emergency fund is the most boring of financial planning advice ever because sitting on a big pile of cash just isn't very exciting, but right now there are hundreds of thousands if not millions of Americans who either wish they had built an emergency fund or are very happy they did. Regardless of your situation, having one I think is really the foundation of a good, solid financial plan.
Southwick: And what's your advice for those who are furloughed and who will eventually get back pay? They will eventually come into a big pile of money...
Southwick: Do you have any advice for that?
Brokamp: Yes. Obviously if you've borrowed any money to do this...
Southwick: Pay it back!
Brokamp: Pay it back. If you've stopped contributing to your IRAs, 529s, or something like that, get back on that track. I think there could be a silver lining to this. If you go without a paycheck for a while, it really forces you to prioritize your budget and I think it's very possible you eliminate expenses that you thought were important and then you realize you don't really need that.
Once you're back on a firmer footing, maybe you don't need cable anymore. Maybe you didn't need a particular service. Maybe you didn't need the gym membership like you thought you did. But then once you get that cash don't go nuts. Don't think now that you've got this big check you're going on vacation or anything like that. Rule No. 1 is to build up that emergency fund.
Southwick: So start listening to this podcast episode all over again. Just rewind. It's a virtuous circle.
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