An Innovative Approach to your Emergency Fund

Contributed by: Timothy Wyman, CFP®, JD Tim Wyman

Innovation isn’t a word you generally hear from financial planners. I have to admit my DNA is more about consistency and research-based practices.  However, at times new thinking and methods might just be what the (financial) doctor calls for.

Traditional Emergency Fund Approach

Take the old Emergency Fund – Financial Planning 101.  You’ve heard the advice; place 6-12 months of living expenses in a safe and liquid vehicle (think savings account or Certificate of Deposit) so funds are available should there be an emergency such as a leaky roof, need for a new hot water heater, kids medical bills, etc.  My sense is that this is a good strategy especially for younger folks starting their careers and families.  This strategy provides discipline and limits the chances of abusing credit, which hampers many young families today.

Innovative Emergency Fund Strategy

However, for more seasoned folks like me, perhaps a change in strategy is in order.  Partly due to very low interest rates (that may even become negative soon) as well as hopefully more financial discipline from years making mistakes, you might consider using a ROTH IRA, Home Equity Line of Credit (“HELOC”), or Securities Based Line of Credit (“SBL”) for your emergency fund needs. Here’s a closer look at all three.

Roth IRA in an Emergency

While the ROTH is intended for retirement savings, they do offer some flexibility in that contributions (but not earnings) may be withdrawn penalty and income tax free at any time.  Hopefully the money is not needed and your so called emergency money can grow tax free.  The downside is that not everyone qualifies due to income limitations - that is, of course, unless your financial advisor is not innovative enough to know about the “Back Door Roth”…we do! If you haven’t yet, read this blog on Back Door Roth IRA Conversions.

Home Equity Line of Credit (“HELOC”) in an Emergency

A HELOC can provide flexibility or access to immediate cash if needed, thus perhaps eliminating or reducing the amount you need to set aside in an emergency fund earning close to zero.  If you are required to use the line of credit, make plans to pay it down or off with other assets over time.

Securities Based Line of Credit (“SBL”) in an Emergency

A SBL is a line of credit secured by a taxable investment account.  In many respects it is very much like a HELOC except that it is secured by an investment account rather than your home equity.  Like a HELOC, the rates are very competitive currently; however they are normally variable rate products.

In the great words of Forrest Gump “IT happens”. The key is to be prepared prior to a crisis by having an emergency fund established, whether it be a traditional savings account, Roth IRA, HELOC, SBL or combination of all three. We’re always here to help you be ready to deal with IT.  

Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a contributor to national media and publications such as Forbes and The Wall Street Journal and has appeared on Good Morning America Weekend Edition and WDIV Channel 4. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), mentored many CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment or financial decision, and it does not constitute a recommendation. Any opinions are those of Center of Financial Planning and are not necessarily those of Raymond James.