With ongoing economic fluctuations, many people are wondering: if you need cash, where are the best places to pull from? While the right answer depends on your individual financial situation, we’ve outlined several common sources.
EMERGENCY FUND
Typically, it is recommended to have an emergency fund with around 6 months of your expenses saved up. Depending on your income structure it may be beneficial to have more than that. For example, if your income is more variable and commission based it may make sense to have 9 months saved. This type of account is typically set up as a savings account or money market account at your bank. It will allow you the flexibility to cover unexpected expenses as well as help you out if you are in between jobs. Typically, there is no penalty to pull money out of an account like this. It is important to remember that once you are able to - place a priority on rebuilding your emergency fund.
HEALTH SAVINGS ACCOUNT (HSA)
A health savings account can greatly assist in times of need when medical expenses arise. If you have a qualifying expense come up, you can take penalty - free withdrawals from your HSA to cover these expenses. In addition to this, you are able to invest within an HSA, which can allow for your money to earn interest tax free. However, if you pull money from this type of account when it is not needed for qualifying medical expenses there are taxes and penalties that apply. It is important to talk to your tax advisor or financial advisor on this type of account.
BROKERAGE ACCOUNT
If you have a brokerage account, this can be used on shorter term needs more easily than a retirement account like a 40l(k) or IRA. If you have made a positive return on your investment in this type of account, there may be a tax liability on your profit. This will depend on how long you held the investment and what tax bracket you are in. As an example, under current rules if you hold an investment for less than a year you will have to pay short - term capital gains rates, which is currently the same as your income tax rate. If you have held the investment for longer than a year it will be taxed as long-term capital gains, which has a different tax bracket. Of course, be cautious of pulling too much out of this type of account as investments are designed to be long term in nature and pulling money out could impact your long-term strategy.
HOME EQUITY LINE OF CREDIT (HELOC)
If you own a home, a home equity line of credit can be a good place to pull money from if you need it. This can work well when you already have an equity line on your home - even if you have not drawn on the assets, but just have it set there in case of an emergency. With this type of equity line, you only pay interest on the credit that you have drawn on, not the maximum value of the credit line. If you need funds fast and do not have a HELOC on your home, it can take time to establish one and there may be closing fees associated with establishing this type of equity line. Many times, the interest rate on HELOC's are variable in nature, so it is important to understand the interest rate environment that we are currently in and the long-term implications of paying just the interest or paying down the principal on the loan.
RETIREMENT ACCOUNTS
Retirement accounts such as your 40l(k) or IRA should generally be one of the last places to look to pull money from. Typically, if you are not retirement age - meaning under 59.5 you may have to pay ordinary income tax on distributions as well as a 10% IRS penalty. There are certain instances that can allow you to get around the penalty and many 40l(k)'s do allow you to take a loan out against the plan. However, it is important to understand what the repayment plan will look like. Be sure to discuss your options with your tax advisor and financial advisor to make the best decision for your specific situation.