Keys to Financial Wellness
By Lorraine McGee, Vice President, Key Private Bank
At one point or another, most of us are going to run into a situation when we need access to a large sum of cash. Maybe it’s for the purchase of a house or home improvement, or maybe it’s for medical expenses, bill consolidation, college funding or some other kind of large purchase or emergency. Regardless, when the need arises, two common questions follow: Where are the funds going to come from? and, How quickly can we get them?”
One question people in need of cash often fail to ask, however, is this: How is this decision going to affect my financial resources in the long run?
The truth is, when an immediate need for cash presents itself, emotions can often be charged. The first instinct is to alleviate the situation as quickly as possible. The problem with this is that the first instinct is often not the right instinct, nor the best solution—especially for the long term.
The following is a list of questions you may ask yourself. . . and points to consider before making any snap decisions.
Should I use my checking or savings?
Maybe, provided you leave yourself enough to pay ongoing expenses and future emergencies. The interest rate paid on checking and savings vehicles is currently quite low, so if it was a choice of leaving the funds in cash or paying the debt, using the cash could be the right solution. However, in some instances, it makes more sense to leave the cash alone and use a credit option for either all or a portion of the need. A discussion with your financial advisor to review your options is important.
Should I sell out my non-qualified investments?
This may cause unanticipated long-term problems. If you generate gains on a sold asset you may have a tax liability that will impact your year-end taxes. In addition, selling assets in a down market can adversely impact your lifestyle for years to come, as it could take much longer to recoup the losses in an extended down market.
Can I borrow against my non-qualified assets?
This is a question for your financial advisor. Some institutions offer an investment secured line of credit that will allow you borrow against your assets, at a modest interest rate, rather than having to sell out of them in a case of financial need. Other institutions may offer margin loans, which typically have higher interest rates and may make you more susceptible to margin calls.
Can I borrow from my annuity?
Annuities do not offer loan provisions, but they do offer a penalty-free withdrawal amount each year until the annuity is out of its surrender period. Depending on how long you have owned the annuity, there may be a surrender charge assessed on any distributions above the penalty-free amount (between 10 and 15 percent, depending on company). In addition, if you are younger than age 59 and a half, there will be an early withdrawal penalty assessed similar to an IRA. Typically, annuities make distributions from asset growth first, so most distributions will be added to earned income for taxes. Annuities can be a great vehicle for long-term investments, but they can be tricky if you need to access a distribution prior to the surrender period as well as prior to age 59 and a half.
What about a personal line of credit?
This could be an option for you. There are variables that are involved and requirements that have to be met in order to be approved for a personal line of credit. The amount available and interest rate charged for a personal line of credit will depend on the institution and your financial background. Timing for an approval on a personal line of credit can vary from less than a week to two weeks depending on the size of the line.
Should I look at a home equity line or loan?
This can be a viable option. Our homes are often our largest asset but are often overlooked when trying to raise funds. A line is able to be used continually, even if you pay it down, whereas a loan is paid down to zero over time and closed out. The loan process can take up to six weeks to complete, so timing has to be part of the thought process. Having a home equity line as a backup emergency fund is a good idea in many situations and should be considered sooner rather than later, especially as you approach retirement. It is important to note that credit score and debt-to-income ratio play an important part in these lending options.
Conclusion
When a cash need arises, a snap decision isn’t always the best decision. You may have more options available than you realize. A discussion with your advisor can help guide you to make the best decision for your immediate, short-term and long-term needs, which will help you stay on the path to financial prosperity.
Lorraine McGee, CFS, CWS, is vice president and relationship manager for Key Private Bank in Central New York. She may be reached at either 315-425-8609 or [email protected]. This material is presented for informational purposes only and should not be construed as individual tax or financial advice. Please consult with legal, tax and/or financial advisors. KeyBank does not provide legal advice.
Think twice before pulling cash from these sources
When you’re in a financial bind, you’re in a bind—bottom line—and any lifeline seems like an attractive option. However, as viable as some sources may seem, they have drawbacks as solutions and can have unforeseen consequences. The following is a list of financing sources you should seriously think twice about when you’re looking to access cash.
Credit cards
Cash advances from credit cards come with very high interest rates. In addition, they can put you in debt for far longer and far larger an amount than you ever anticipated. This can have a negative impact on your debt-to-income ratio and your credit score, which can make it difficult for you to obtain the credit approval you need to secure loans for major purchases.
Short-term and payday loans
While a viable option, these should be used as a last resort because the interest rates are extremely high and in some cases prohibitive. Amounts available through pay day loans are typically very low, which makes them more trouble than they are often worth.
Life insurance
Cash value built up in life insurance is available to borrow, but it is also there to keep the policy healthy and running smoothly as you age. Although the premium you pay may not change, the cost of insurance rises as you age and the cash value smooths out the difference between premium and cost. If you borrow too much of the built up cash value, it can handicap the policy in the long term and lead to the policy running out before you need it. The interest rate on these loans is typically high as well, and can lead to significant payments over time.
Retirement accounts
Roth IRAs, traditional IRAs and Simple IRAs do not have loan provisions, but you can take a distribution directly from your investment. The catch: negative impact on long-term growth; distributions are taxed as earned income, which impacts your tax rate; and early withdrawals are penalized. In addition, depending on the asset class you have invested in, there may be sales charges. There are certain circumstances in which the penalties may be waived, so you should review this with your advisor.
Family and friends
The viability of this as an option varies from situation to situation, family to family. So understand your situation and your family. Too often, families blow up and destroy relationships over money. If you have any concerns about this happening, explore other options first. However, if your family dynamics permit this solution, a good practice would be to have a document that clearly spells out the loan, the interest and the repayment schedule.
