Ryan M. Kittredge is a partner and financial advisor with Carr Financial Group in Worcester and can be reached at ryan@carrfinancial.net.
Updated: August 17, 2020
know how
Creative strategies to generate liquidity
By Ryan M. Kittredge
This year has brought a sharp slowdown in business revenue and record unemployment claims from systemic layoffs. Many individuals are experiencing a sudden cashflow squeeze, and while some anticipate these being temporary challenges as their business begins to pick back up or they seek new employment, everyone impacted needs a plan in the meantime to bridge this income shortfall.
Government stimulus has provided a short-term cash boost in the form of Paycheck Protection Program loans to small businesses, stimulus checks, and enhanced unemployment benefits. This relief is coming to an end, and while there is movement toward a second round extension of these subsidies, it is likely the next round will be to a smaller degree, and is unlikely to be a longer-term solution to your challenge.
You can follow the basic financial wisdom of evaluating expenses to see where cuts can be made, such as cancelling the cable bill or suspending the daily trip through Starbucks. The reality, however, is many people do not have the luxury of cutting their expenses enough to have a meaningful impact, and the majority of folks still in their working years don’t have enough cash on hand to replace their income for several months. In these cases, you need to get a little creative with strategies to generate liquidity.
Use your home as a back-up emergency fund. After emergency savings have been exhausted, or when they get below a critical level, a home equity line of credit can be used to borrow against to cover expenses or replenish your emergency savings. These loans provide you the ability to draw on a pool of equity, make interest-only payments for 10 years, and then the loan amortizes the principal and interest payments over another 10 years. The closing costs are typically only an appraisal fee, which may be waived in some instances.
Enhanced 401(k) loans. Financial gurus warn against borrowing from your retirement account, but it can be a valuable option if you weigh the risks and benefits. Due to the CARES Act, if you or a family member have been financially impacted by the virus such as a job loss or illness, you can borrow up to 100% (up to $100,000) if your employer plan allows for it with the option to delay repayment for up to one year. While the money you borrow ceases to be invested in the market, the interest on the loan is paid back into your own account.
Tax-smart portfolio distributions. If your need for liquidity is likely to be longer in duration, and you have exhausted your other available options, liquidating your retirement portfolio may be necessary. If you have an after-tax non-qualified account, you may want to start there as the capital gains tax rates are more favorable than ordinary income. As an alternative, your investment company may offer the ability to establish a securities-based line of credit, which allows you to use your investment portfolio as collateral to borrow money, without the tax bill and potential opportunity cost of liquidating your investment holdings. If an IRA is your only option, the CARES Act has temporarily waived the 10% early distribution penalty.
With any financial and tax strategy, you should consult with your professional advisors prior to making any decisions. Make sure to take a comprehensive overview of your situation and evaluate all available options to optimize a plan best suited for your unique circumstances.
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