Don’t Be Your Nest Egg’s Biggest Enemy: Plan for the Unexpected
Many of the biggest risks your retirement accounts face are unavoidable and often unforeseeable. Whether you’re dealing with a big expense, such as a medical crisis or a prolonged disability that prevents you from saving, or smaller things, such as unexpected car or home repairs, building and maintaining an emergency fund is a key part of keeping your retirement nest egg intact.
Filling Your Rainy-Day Fund
It’s easy to let the day-to-day bills and the things we need or merely want to buy right away take priority over building savings. We don’t like thinking that bad things can happen, so it can be hard to admit that we might need cash for an emergency. But the fact is, liquid cash that you can access quickly is critically important to avoid building credit card debt or having to tap retirement funds when something bad happens.
Remember these points as you begin to build your emergency fund.
• Admit you’re not invincible—things actually can happen to you that you won’t expect.
• Give yourself a pay cut. No kidding. Many people adjust their spending based on what’s in their checking account. If you work this way, try having 2 percent of your paycheck direct deposited into a savings account. Make your savings out-of-sight, out-of-mind, and you’ll build an emergency fund before you know it.
• Keep an eye out for small windfalls and extras, like cash gifts from friends, bonuses at work, and even cash refunds when you return something you don’t want to the store. A lot of the time, this money isn’t part of your monthly budget, so take advantage of the extra cash and put it toward your emergency fund.
Financial planners suggest keeping enough cash in your emergency savings to cover expenses for three to six months. This time frame is a good rule of thumb because many people would need about that long to find a new job if they were laid off. Disability policies usually have a 90-day waiting period, so you would need savings to cover expenses until policy benefits started. What’s more, basing your savings amount on your expenses makes the account size fit with your lifestyle. Think of it this way: the emergencies you face are affected by the cost of the things you buy; an emergency repair on a $40,000 car is going to cost much more than a repair on a $10,000 car.
Full Account
Growing your emergency fund is often more about psychology than about having the cash to save. Many people, who’d be hard-pressed to save, find it easy to let small monthly costs for things they want, and don’t necessarily need, gradually add to their expenses. Think of needs as things that keep you safe, warm, healthy, and fed—in the short term and in the long term. Of course, wants are those things that might make life more fun. Upgraded cable TV is a want; emergency savings so you can pay the electric bill if you’re laid off is a need. Spend on wants only after you’ve covered the needs.
If you find it tempting to let small monthly expenses leak into your budget rather than to add to your savings, the challenge is in your head, not your wallet. Next time you find yourself saying “it’s only another $20 per month for this splurge,” try adding that $20 to your savings instead of spending it. In time, your mindset will change, and your emergency fund will grow.
A credit line, like a home equity line or available credit on a credit card, isn’t a long-term alternative to building savings, but having credit available can be a good short-term safeguard while you’re building your emergency fund. Earmark the credit line for emergency purposes only; don’t be tempted to use it for costs you can plan for, such as vacation or holiday expenses.
Protecting Your Nest Egg from Medical Expenses
Medical expenses are one of the biggest threats to your financial security. Health-care costs are high, and you’re not always in the position to comparison shop when the need for care arises. Your emergency fund can help pay for the things your health insurance policy doesn’t cover. Make sure your health insurance policy is complete enough to protect you from having to draw down your retirement funds to pay for medical care.
Many people have health insurance as an employee benefit. In this case, your employer has offered a limited choice of health plans to choose from. If you get a choice—or even if you don’t—find out what your plan will pay for and what your total cost could be if you had a major illness. Check the following features of your policy:
• Premium. This is the amount you must pay each month in order to have coverage. If you leave your job, your employer will let you keep your coverage under a plan called COBRA (Consolidated Omnibus Budget Reconciliation Act). You keep the same policy, but the subsidy your employer may have been paying to keep the premium lower for employees isn’t there any more. If you pay the full premium yourself, this could mean a higher premium when you’re unemployed, so include enough money in your emergency fund to pay the full unsubsidized amount for six months.
• Co-pay. This is the amount you have to pay when you receive medical care. Co-pays are usually billed at the time of each eligible event, such as a visit to a doctor or the emergency room or when you fill a prescription. The co-pay can be different for different services. The co-pay for a doctor appointment is probably lower than a less-likely event such as an emergency room visit or being admitted to the hospital. Health plans with higher co-pays will carry a lower premium than similar plans with lower co-pays. If you decide to save money on the premium, it’s important to have money in savings to cover higher co-pays if they arise.
• Deductible. The deductible is the amount you have to pay before the policy benefits kick in. For example, if your policy has a $500 deductible, you pay the first $500 for care, and then the insurance pays from there. You still have to pay co-pays even after reaching the deductible. If your spouse, partner, or kids are on your plan, you will probably have a deductible that applies to the whole family. Make sure you have the amount of the deductible saved in your emergency fund.
• Maximum annual out-of-pocket expenses. Because you’re still paying co-pays for services even after meeting the policy deductible, most policies will specify an annual out-of-pocket maximum. This limits the amount you will have to pay under the policy each year. Premiums and some co-pays don’t count toward the out-of-pocket maximum. A policy with a higher maximum will have a lower premium than a policy with a lower maximum. The maximum is a good guideline to check your emergency fund against. If you have three months of expenses in your emergency savings account plus your health insurance policy out-of-pocket maximum, then you’re in good shape to avoid having to tap retirement plan funds in a medical emergency.
• Lifetime maximum benefit. This is the total amount the policy will pay for covered care, forever. Once you’ve used up this amount—unless you live in a state that requires insurance companies to cover everyone who applies and can get another policy—your coverage ends. Check out your state’s official website for information on whether or not it compels companies to offer guaranteed issue policies that don’t deny you if you have a pre-existing condition.
A company can afford to charge lower premiums if it has a low lifetime maximum benefit of $1 million or $2 million. But you’d be amazed to see how fast a million dollars in medical bills can rack up when you’re dealing with cancer or some other major medical catastrophe. It’s best to look for a policy that has an unlimited maximum benefit even if the monthly premium is higher because of it.
Nest Eggs
The financial security of your insurance company is important—what good does coverage with a low premium and rich promised benefits do if the company can’t pay your claim? Ask the company for its ratings from Standard and Poor’s or AM Best to make sure you’re working with a company that has strong financial credentials. Check www.AMBest.com or www.StandardandPoors.com for the insurance company’s rating and an explanation of what the rating means.
Forced Out: Long-Term Disability
A big part of building and protecting your retirement nest egg is investing money into it regularly. This can be hard to do if a long-term disability keeps you from working because you’re eligible to contribute to an IRA or other retirement account only if you or your spouse has earned wages. But that’s not the only problem if you’re sick or hurt and can’t work. Not having an emergency fund or disability insurance to help you cover living expenses while you’re not working can put your retirement accounts in jeopardy.
Nest Eggs
If you’re permanently disabled and can’t work or earn money at all—in the IRS’s words, “you can not do any substantial gainful activity”—then the withdrawals you make from your IRA before age 59 ½ won’t carry the extra 10 percent penalty.
There are two types of disability insurance: short-term and long-term. Each pays a benefit equal to a percentage of your wages when you can’t work because of illness or injury. Unlike the coverage under your employer’s workers’ compensation insurance, the injury doesn’t have to be job-related for your disability insurance to start paying benefits. Short-term disability (STD) coverage usually starts after only a few days of disability and most often lasts from 9 to 52 weeks. Some policies require that you exhaust your accumulated sick days at work before benefits begin and don’t pay a benefit if the injury is work-related and covered by workers’ compensation insurance.
Long-term disability (LTD) benefits have a waiting period of 30 to 90 days and pay you for a longer period of time than short-term coverage does, usually 5 years or to age 65, whichever comes first. Your long-term disability coverage could also pay a partial benefit if you can work but at a lower salary than you were once earning.
Many employers provide one or both types of disability insurance as an employee benefit. You can buy either one on your own if they don’t, but the cost of short-term disability can be prohibitively high. That’s why it’s a good idea—and smart money management—to save the premium by self-insuring and keeping your emergency fund full.
Nest Eggs
Pay the premium on your long-term disability insurance yourself if you’re given the option. Disability benefits from a policy you paid for are not taxable as income, so you get to keep more to spend when you really need it. You’ll owe taxes on your benefit if your employer paid the premiums.
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