The U.S. just passed its one-year mark of the COVID-19 pandemic. From social distancing to the loss of income and lives, most of us have been affected in one way or another. With these changes, the way we do business has changed for the foreseeable future, and so has our personal finances. We have experienced changes not only in our balance sheets, but also in the way we interact with our money.
From personal experience, navigating through this pandemic has been a challenge. I was diagnosed with COVID-19 in May of 2020 and missed work for two months, which caused me to lose income. During that time, I relied on colleagues to help me with everyday tasks of servicing clients. At the same time, my household expenses did not stop, and neither did the office’s overhead costs. By planning ahead of time, we were able to navigate through the ongoing pandemic and continue our operations. Had things not turned out for the better, we had a contingency plan that would help with cash flow through various insurance policies and earmarked accounts. Below are some of the strategies that helped us weather the storm.
Both the business, our office, and my household had access to 3–6 months of monthly expenses. Because we created an automated savings plan that allowed us to transfer money from checking to savings, we were able to slowly but surely save enough money to carry us over for a few months. We also set up an automatic purchase of low-cost mutual funds through TD Ameritrade, our preferred custodian. In doing so, we had exposure to the market through dollar-cost averaging, which created a secondary buffer of liquidity.
When used appropriately, insurance coverage provides an excellent hedge against the unforeseen. Some insurers, such as AIG and Mutual of Omaha, offer products that replace income for a period of time. If the covered person is unable to work for a period of 15–180 days, these policies provide a much-needed stream of income. Self-employed individuals will usually buy these coverages via short-term disability or long-term disability policies. Occasionally, they purchase critical illness coverage. Business owners also have access to key-man policies, which replace a key person’s ability to generate income if they are unable to work and bring revenue for the employer. Some life insurance policies also offer an advance of the death benefit if the insured has a terminal or chronic illness.
With proper life insurance, individuals and business owners can create a contigency plan in the event of an unexpected death. Let’s take Mike as an example. He is the breadwinner at home and makes $85,000 per year. Also, he is married and has a 1-year-old child. However, he and his wife hold a mortgage for $200,000. In the event that Mike experiences a premature death, his wife would need to replace about 70% of his income for the next 18 years and pay off the mortgage. This gives us a total of $1,271,000, plus final expenses of $20,000, which brings his total need for life insurance to $1,300,000. If managed properly, it is enough money for his family to continue their lifestyle. In my case, if I were not able to recover, my family and business would have enough cash-flow to continue without me.
The CARES Act of 2020 allowed individuals to tap into their retirement savings– but only in the year 2020. Although only recommended as a last resort, the liquidity in a 401(k) or qualified retirement account can provide temporary relief. The CARES Act allows an individual to withdraw up to $100,000 from a qualified retirement account and repay the withdrawal or tax over a period of 3 years, so long as the distribution is coronavirus-related. This means the owner would need to amend their tax returns to recapture any tax withholding or prepaid tax if the funds are returned in less than 3 years. Additionally, the 10% early withdrawal penalty is waived, but federal and state taxes are still due.
Individuals also had the option to borrow funds from their qualified employer-sponsored retirement accounts, which could be paid back in up to six years. . Any unpaid amounts at the end of 6 years or termination of employment would not qualify for this special treatment, triggering its corresponding tax liability.
The lending industry has gone into a frenzy as record-low interest rates have made home purchases and refinances cheaper than ever. 30-year mortgages are going for as low as 2.65%, and 15 year-mortgages for as low as 1.75%. Although refinancing is generally recommended, there are times when refinancing does not make sense. If not done correctly, debt consolidation becomes a potential pitfall as you pay down unsecured debt and use your home as collateral. You may have lower monthly payments by refinancing into a longer-term loan, but you might also end up paying more in interest over the next 15 to 30 years. Nothing is truly free, so you may find that taking advantage of a “no-cost” refinance is not a good move. The closing costs can be wrapped into the final loan, increasing the final balance and interest paid over the life of the loan. Lastly, it is generally not recommended to take equity from a home through a cash-out refinance to invest.
As always, discuss these any options with your financial professionals. Please reach out with any questions–SVF is here to help!