There are several strategies that will help investors use their retirement assets, should they need to, in the most efficient ways possible.
No one wants to change their retirement strategy because they are between jobs, or worse, because they need to use those assets for daily living. These dollars are hard-earned, likely over a long period of time, and invested on a pretax basis. They are invested with a long-term strategy in mind.
However, we are in a unique economic time. Economic recovery is only now under way, with many people still between positions or underemployed. There may be instances where an individual needs to tap his or her retirement savings to make ends meet.
Such actions should not be taken lightly. But there are several strategies that will help investors use their retirement assets, should they need to, in the most efficient ways possible. Before making any moves, be sure to consult with a financial advisor for advice specific to your situation.
Whether someone is newly in transition or has been between positions for some time, the first—and most important—step for financial security is to create a budget.
A monthly financial plan will help people determine how much they need to spend as well as how much they are spending in ways they did not intend. For those who are thinking, “I know how much money I spend, I don’t need a budget,” think again. Most financial advisors have yet to meet a client who did not benefit from a written budget.
In most cases, an individual will then want to reallocate assets so they are more conservatively invested. In the case where someone was prepared for a job loss, he or she may have already done this. Hopefully, it was done in a systematic and methodical manner.
On the other hand, suppose someone does not have sufficient cash to cover daily expenses, his cash cushion has been exhausted, or he needs to adjust his portfolio to reflect the new situation. What then? Individuals may not want to convert large portions of their portfolio to cash all at once, since they don’t know whether the markets are at a high or low point, and they could be employed again in the near future. Instead, perhaps in the same way that they dollar cost averaged into investments, they reverse the process and dollar cost average out of investments.
One way to do this is to convert, for example, two times a person’s monthly expenses to cash each month. In this way, an individual will have the amount of money needed for basic living expenses while also slowly building up additional cash reserves. This makes a portfolio more conservative, and makes more cash available (should it be needed) while still providing the opportunity for growth. It’s important to note that this strategy does not protect against a market decline. However, by taking the money out on a regular basis, in relatively small amounts, risk is significantly lowered.
For unemployed or underemployed individuals who find themselves in the unfortunate position of needing to use retirement assets to make ends meet, there are bills that should explicitly be paid with those assets.
Those who are on COBRA or who have purchased their own health insurance policies should pay those expenses from their retirement plan. For individuals who have been unemployed, the 10 percent penalty for early withdrawal is waived. As an added bonus, the costs of health insurance (and medical expenses) are tax deductible once they reach 7.5 percent of adjusted gross income, which is now much lower due to unemployment.
Withdrawals for post-secondary education expenses, while taxable, are not subject to the 10 percent penalty. At first blush, it seems great that there is no penalty, but what really hurts is paying the income taxes. Remember, though, that while unemployed, a person’s income tax rate is likely substantially lower than it was when he or she first put the assets into a retirement plan. This means there can be a tax advantage to withdrawing them.
Of course, every situation is unique. Should you find yourself in transition, whether for a short or a longer time, it can be a period of extreme stress as you wrestle with the uncertainties of making your next career move. It is precisely in these circumstances that a professional financial planner, acting as an objective advisor, can help you navigate between the twin dangers of indecisiveness and extreme action, which can lead to long-term financial damage.
Seth Becker is a Registered Financial Consultant and financial planner with Oakstone Financial Management in Gahanna. He can be reached at (614) 775-9469 or firstname.lastname@example.org.
Reprinted from the June 2012 issue of Columbus C.E.O. Copyright © Columbus C.E.O.