Saving is difficult when life is normal and the sun is shining. But what happens if you lose a job, face a divorce or a medical diagnosis? Read on for advice for overcoming income shocks.
Jason is 52. He is married with 2 kids (ages 10 and 12). He has a home, a job and a 401k. Like most of us, Jason’s life is full. Saving for retirement and kids’ college tuition is on his mind occasionally – but let’s be honest, we all spend more time planning our next car purchase and the upcoming vacation than thinking about retirement.
And even when we do make plans, life often gets in the way. A recent study by the National Endowment for Financial Education found that “income shocks” (disruptive events that create a setback for retirement savings) affect most Americans. In fact, 96% of Americans experience four or more episodes where their earnings drop by 10% or more over their lifetimes. Bouts of unemployment or underemployment, birth of a child, divorce, illness and death in the family can throw in wrench into the best-laid financial plans.
Since income shocks affect virtually everyone at some point during their working life, it makes sense to have a plan. In fact, several plans are better. Here is what you can do today to be best armed and prepared to overcome income shocks.
Before the shock: have a strategy.
It is comforting to think that job loss or serious illness won’t happen to you. I certainly hope it doesn’t! However, if we are realistic, there is a good chance that at some point, something will affect your ability to save for retirement at the optimal pace.
Therefore, it pays to have a plan. Sit down with your spouse (and your financial planner) and develop a few contingencies. What would you do if one or both of you were unable to work for a year? What if a family member needed an unexpected extended stay at the hospital?
Here are a few more questions to help you frame your answers and possible solutions.
- What are you good at? The answer to that question may help identify possible additional sources of income (side gigs, alternative employment).
- Where could you cut discretionary spending if you absolutely had to? Sketch out a “bare bones” budget that would shrink your spending down to what is vital.
- What are your assets and reserves? Look into sources of additional cash while being alert to long-term consequences of your decisions (like penalties and taxes).
In the best-case scenario, your spartan plans will stay locked away in the drawer and never needed. Should the unexpected happen, you will have a starting point.
In addition to crafting your Plan B and Plan C, be sure that you build a healthy emergency savings account. We cannot always predict a job loss or the need to pay the deductible for a hospital stay. Having liquid resources on hand is unbelievably liberating.
During the shock: analyze your options.
If an income shock ever happens to you, begin by laying out the possibilities. I know that it is extremely difficult to be resourceful and creative under pressure. Do your best, enlist professional advice and research local resources that can support you.
After you have identified your options, choose the one that is best aligned with your situation and least damaging in the long run. In other words, don’t tap your 401k (incurring tax penalties along the way and foregoing the benefit of cumulative growth) until you have exhausted your emergency savings.
After the shock: rebuild.
Once the shock waves have subsided, take stock of where you are and make a commitment to get back on track. Re-activate the automated savings deposits that you may have suspended during the heat of the crisis. Look into your eligibility for catch-up contributions. Re-assess your goals and align your financial behavior to match them. This is your new normal, so dust yourself off and get back on that horse.
Surviving financial storms: plan, evaluate, rebuild.
Major life events like birth of a child, marriage, divorce, job loss, accident or illness can disrupt our financial plans. Money stress makes everything worse. Do what you can to create alternatives and make good strategic decisions based on careful analysis, not pushed by panic. After the income shock event passes, commit to getting back on track. Life happens to all of us. Keep moving forward and enlist the help of a trusted financial planner to guide your way.
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