PLANNING FOR FINANCIAL EMERGENCIES

A survey earlier this year by Yankelovich Partners for the Lutheran Brotherhood found that 55 percent of Americans have no plans in place in the event of a personal financial emergency. Those older than 65 and those aged 18 to 34 were particularly at risk, according to the survey, though many Certified Financial Planner practitioners caution that a devastating financial emergency can strike most any age or income level.

Potential financial emergencies include the loss of a job or small business, legal troubles, a serious illness or long-term disability, a divorce, a natural disaster such as a fire or hurricane, or the sudden need to care for an aging parent. Even something as small as a major car repair can tip a family over the financial edge. Here are some recommendations for preparing for the unexpected.

Plan ahead. With a booming economy and expectations that the stock market will continue to perform well, many families may feel little need to plan for a financial emergency. But good markets don't last forever, and even in a booming economy one can lose a job.

So first, examine your household finances to see what resources you have should you suddenly face a loss of income or large unexpected expenses. How quickly could another family member find work? Do you have easily accessible, penalty-free savings to tide you over? Loan sources such as home equity or a personal line of credit? What would you actually be able to do if something happened? Many families simply choose to ignore even thinking about something going wrong-until it happens.

Plan an emergency budget. Establishing a regular budget or spending plan is a good idea for any family. But you also might want to develop an emergency budget-what's the minimum amount of income and expenses you would need to survive in the event of a financial crisis? This means a bare-bones budget-mortgage or rent payments, transportation, clothing, food, insurance premiums, and so on.

Obtain adequate insurance. One of the frontline defenses against financial catastrophe is insurance. Most people have life insurance, a homeowner's policy and auto insurance. However, homeowners often don't have extra liability insurance and renters frequently overlook renter's insurance, which covers the loss of personal property. Millions are not covered by medical insurance, even when it's available and affordable, and the majority of workers are not covered by adequate amounts of disability insurance, which replaces a portion of income lost because of a disabling injury or illness. Even fewer buy long-term care insurance, either for themselves or their parents, despite the fact that a nursing home stay can quickly deplete a family's savings.

Set up an emergency fund. There is much debate, even among financial planners, about how large an emergency fund you should have and where you should keep the money. Some say you should have at least three months, six months, even a year's worth of expenses reserved in a savings account or money market. Others don't like to see too much tied up in low-yielding accounts.

To a large extent, the size of your emergency fund depends on your financial circumstances. For example, if both spouses work in stable jobs with different employers, the loss of a job by one of the spouses will have less impact than if the family relies on a sole breadwinner. Having adequate insurance and healthy investments lessens the pressure for a large emergency fund. One piece of advice: try not to rely on retirement accounts for emergencies because of the tax bite (unless you take out Roth IRA contributions) and loss of tax-favored growth from withdrawals.

Consider loan sources. Careful planning should reduce the need to borrow for an emergency. But if you must borrow, keep these points in mind. Establish a line of credit in advance of financial problems. Once you lose a job, for example, it's tough to get the line of credit. Consider using a home equity line of credit, which is tax deductible, or a personal line of credit (a business line of credit is tax deductible). Try to avoid borrowing from your retirement plan or life insurance cash values. Failure to repay could result in a big tax bite. Also avoid credit card and payday loans-they're very expensive.

This article was produced by the Consumer Affairs Dept. of The Financial Planning Association and provided to you courtesy of Nigel B. Taylor, CFP, Santa Monica, California. If you have any questions or concerns regarding this, or any other financial topic and are a resident of Southern California, please call me at 1-800-444-2237 (California residents only please), or click on the "MORE INFO" button to arrange for a free initial consultation in the comfort of your home or office.