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15 Ways to Plan for Financial Worst Case Scenarios Print E-mail
(9 votes, average 4.78 out of 5)
Personal Finance - Education
Written by Ahmed Amr   
Monday, 19 July 2010 04:08
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With the more accurate gauge of unemployment hovering at about 17% and with some estimates indicating that 30% of households have experienced some form of job loss, there are more reasons now to be cautious with your financial planning. While the majority of Americans have managed to endure the Great Recession and emerge financially intact, millions of families have been less fortunate. For whatever reason, many people didn’t plan for the worst case scenario. It’s all water under the bridge now, but there are things people can do to mitigate the unbearable burden of prolonged unemployment. For one thing - we should plan for it. It might never happen but if it does, make sure you retain the ability to hunker down, weather the storm and take care of your family. Here are 15 key points in 3 areas to help you plan for the worst.

Utilize Retirement Accounts:

Retirement accounts are meant for your golden years, but they can, and should be tapped in a crisis. While some experts disagree, I would ask them what's the point of saving your money for retirement if a prolonged period of unemployment wrecks everything so badly that your life goes into a tailspin? Retirement plans should have a dual purpose - to make sure we are comfortable in our old age and to create a buffer for prolonged involuntary retirement during our peak earning years. The dual purpose of retirement accounts is all the more incentive to save while you have gainful employment.  

No matter what your age is, there are many reasons why IRA and 401K plans are great for emergencies.

1. If you are married and one spouse loses his or her job, the other one can tap a 401(k) plan by taking out a loan. Loans are to yourself, so the interest you pay is paid back into the account. Loans are limited to 50% of the account value up to $50,000.

2. If you’re under 59 1/2, you might have to pay a 10% early withdrawal penalty. But the penalty can be waived for a variety of reasons including if you have medical expenses above 7.5% of AGI or if the distributions are not more that the cost of your medical insurance. You will have to still pay taxes but if your income is low, you won't pay much.

3. If you use the money to go back to school, the penalty can also be waived. There is also a way to prematurely take the money out in equal installments over a number of years without paying the penalty. To make sure you know what you’re doing, consult with your financial advisor or an accountant before taking advantage of this option.

4. If worse comes to worse and you have to file for bankruptcy, your IRA and other retirement accounts cannot be touched by creditors. Bankruptcy is not something most of us contemplate but you never know where life takes you and retirement accounts are one way to emerge from bankruptcy with some of your assets intact. Even if you only have ten or twenty thousand in an IRA, it will help you deal with loss of credit and give you a better opportunity for a fresh start.

5. Withdrawals from your IRA will help augment your meager unemployment checks. If you’ve also taken the standard advice to save up six months worth of expenses in an emergency saving account, you can probably survive two years without a job. Hopefully, that is long enough to get hired.



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Derek Allen  - Worse Financial Decisions You Can Make To Guarante |2010-08-11 17:46:31
Great article! There are several things we must avoid in order to become financially stable and not retire broke. An interesting article on this subject is:

Worse Financial Decisions You Can Make To Guarantee Bankruptcy During Retirement!
frugal nomad  - we'll look it up |2010-08-12 07:51:24
Thanks, we can all use a little more financial education. We'll look it up.
carloan calculator  - 15 Ways to Plan for Financial Worst Case Scenarios |2010-07-20 19:06:28
Great post that is definitely essential especially in times where recession takes place. One of the major reason of financial struggle is lack of preparations and this article showcases the possible way out of a big problems that affects our financial situations.
flamaest |2010-07-19 13:07:27
From point number 1 about 401k loans:

"Loans are to yourself, so the interest you pay is paid back into the account"

If you don't have any money, how are you going to pay this back? The first loan payment on the 401k loan is due almost right away. If you cannot make a payment, and although this is an unsecured loan, your 401k company will inform the IRS that you defaulted and you will be in some serious SOL come tax time, since now you will owe the IRS about 50% of that loan.

I'm also not so sure about: Shelter: #2.

"Depending on the state you live in, your house is another asset that you can hold onto after bankruptcy. It’s easier in some states than others. Know your state's laws."

This sounds like "Allodial title" and if this is what you meant, it's not done almost anywhere anymore. Too bad really.
http://en.wikipedia.org/wiki/Allodial_title


Also, I didn't see any mention about drawing unemployment, this should be your very first call to get some money if you are laid off. You worked for this unemployment benefit, get as much as you can ASAP.

F.
frugal nomad  - the loan term on 401k can be up to five years |2010-07-19 13:50:37
With a 401K plan, you can borrow maximum up-to 50% of the account balance up to $50,000. Loans from a 401k plan can be ammortized for up to five years - even longer for real estate purchases. The thing is this - you won't refuse yourself a loan and you can set the interest rate. You do have to make monthly payments it back but you'll get a lump sum to help you weather the storm.

By the way, you have to make your loan arrangements with your employer who is administering the plan. So become familiar with the exact process your employer has set up for taking loans against your 401K.

Once you're gainfully employed, keep making the payments and you'll build up your retirement account again.

When you're laid off, you can just take the money out and not pay the penalty, but you'll still have to pay the income taxes but chances are you'll be in a lower tax bracket.

Well, ofcourse, people should apply for unemployment. We just assumed most people knew that although you might have a point - some people who have never been unemployed think it's like getting welfare and it isn't. It's something that was part of your compensation package - you've been paying premiums for it and there is no shame in collecting it. And if you don't apply right away, they might not credit you for the weeks you missed.
Nmerriam |2010-07-20 08:21:39
Allodial title isn't what he's talking about, there are about a half-dozen states with Homestead Exemptions that prevent forced sale of your home in bankruptcy. Texas only recently created any property value limit, after Ken Lay (of Enron fame) went bankrupt but got to keep his multi-million dollar mansion.
frugal nomad  - staff |2010-07-19 12:23:49
Sorry - sometimes we make mistakes. Thanks for bringing that to our attention. We've corrected the article to reflect that. And we encourage other readers to set us straight and enlighten us. The last thing we want to do is pass off inaccurate or incomplete information. In this case, we just didn't notice the cutoff date.

Thanks again - haverwench - you're turning out to be one of our best editors.
haverwench  - Cutoff for reduced COBRA premiums |2010-07-19 12:06:57
"Under new Federal laws, you only have to pay 35% of the premium for the first 9 months you are unemployed, the balance is paid by your former employer which is then reimbursed by the federal government."

This applies to you only if you lost your job prior to May 31, 2010. Any later than that and you are on your own. Also, you must not be eligible for any other group coverage (such as a spouse's plan or Medicare). http://www.dol.gov/ebsa/newsroom/fscobrapremiumreduction.html
Frank M  - 401K loans |2010-07-19 16:26:51
I used to work for a large 401k administrator. In most cases a 401k loan will not help you if you lose your job. Every plan has different rules but in a majority of the plans the loan option is terminated when you seperate from the company. The reason is simple. The loan is meant to be paid back through an automatic payroll deduction. Some plans had provisions to let you make seperate payments if you were on disability. But seperation generally negates the loan option.
frugal nomad  - Take out the loan the minute you get a pink slip |2010-07-19 18:05:28
You can still take out the loan when you get your pink slip. Many places will give you as much as two or three months notice of a layoff. It still gives you the option to take out the loan.

The 401K plan can remain with your employer even after you terminate your employment there.

If you have a five year loan, I don't imagine they can oblige you to pay it back once you terminate. It would seem to me that the automatic withdrawl can go against your bank account.

The other option you have is to roll it into an IRA and set up a distribution from there.

Here is a link to an article to explain how you can withdraw money penalty free from an IRA.

http://www.smartmoney.com/personal-finance/retirement/tapping-your-ira -penalty-free-7958/
Frank M  - 401k loans |2010-07-20 04:28:16
Yes but when you seperate from your employer the 401k loan that you took out 3 months before will be called. Usually within a short period of time (60-90 days). If you can't come up with the payoff amount from some other source not only will the money be gone from your 401k - you will owe regular income tax on the full loan amount.

I understand this is a free site. But you should be careful what type of advice you are giving your readers.
flamaest |2010-07-20 08:31:45
I concur, this is also what I was told by my Fedility 401k plan advisor.
frugal nomad  - How to dodge penalties |2010-07-20 09:13:44
First of all we're very careful about the advice we give. Our general advice is that you shouldn't just contribute to 401K for retirement but as last resort account when you have emergencies like long term unemployment.

You will pay penalties and income tax for early withdrwal but if you're unemployed for a long time and your only source of income is an unemployment check, you'll probably have no income tax or be in a very low income bracket. So the only 'tax' will be the 10% barrier. To make sure you play it right, wait till the january after you become unemployed so you'll be in a new tax year. By the time you have to pay taxes and the penalty - it'll be 16 months - 20 months if you file for a late extension. So if you're laid off in june, tap your IRA or 401K in January. If your loan is called by the administrator in six months after the pink slip, you still have an additional 20 months to deal with the tax consequences. And if you're still unemployed - the only tax you will incur is the 10% penalty. When you consider that you've probably saved 25% in income taxes when you stashed the money in a 401K when were working, You end up having saved 15% ahead.It's still a great incentive to put as much as you can in a 401K plan while you're working.

The loan against a 401K should allow you to get to that January date. That way you will default in the new 'low income tax year' even if the loan is called by your plan administrator.

That doesn't even take into account that you can waive the penalty by using it to go back to school. If you wait to take till January, and you have no other source of income. You might very well end up paying no taxes at all.

Remember we're advocating maxing out on your 401K while you're working so you can have tax advantages while you're making money and a saftey cushion during times of prolonged unemployment and we recommended the loan option. But there are a number of ways to deal with that. You can shuffle funds around pay back the 401k and roll over your 401K into an IRA and set up the penalty free distribution option. If you roll over the 401k a home business 401K 'One Person Plan,' you can take a tax-free penalty free loan on that.

In fact, a lot of small business people use the One-Person 401(k)plans to shelter their income and then give themselves low interest free loans.

Whether you end up dodging the penalty or not, you still have an incredible emergency fund to tie you over during prolonged peri...
frugal nomad  - more advantages to 401k and IRA savings |2010-07-20 09:17:39
There is one thing you also need to keep in mind. Say there is no way to dodge the 10% penalty. If you play it like outlined above and end up having to pay the penalty 2 years on - it's probably the cheapest loan you can get and nobody can refuse to loan you the money. It's yours and you make that decision.
 
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