Prepare For A Budget Meltdown By Conducting A Financial Fire Drill
You're fired! Now what? It's the nightmare scenario, and you can prepare for it by conducting a financial drill. Take a moment and pretend you have no income. Ask how you would pay pay for rent and food, and what lifestyle changes you could make on two week's notice. To guide your planning, the New York Times has a few unorthodox and downright scary suggestions that are worth considering in a worst case scenario.
Spending: Slashing spending should always be your first move, even in good times. Restaurants, movies, cable, vacations, all of these can go. The Times also suggests taking a close look at your car. Is it nice? Good, then ride it 'till it's dead. "Mr. McKinley, who drives a 2003 Honda Pilot with 80,000 miles on it, suggests flares, blankets and a backup cellphone for those who worry about car trouble."
Borrow: Yes, borrow. Since your credit will dry up as your financial situation worsens, tap your credit lines while they're still available. This means charging large expenses (read: critical repairs, not new plasmas) to your credit card, freeing up your savings for other vital expenses. If you don't expect to make money anytime soon, borrow from your family.
This is, of course, extremely dicey advice that should be reserved for emergencies. Even then, don't try it unless you have savings in the bank and think you'll soon be working again so you can repay your newfound debt.
Rejigger Your Assets: Guard against a financial double whammy by switching your retirement funds to a more conservative allocation. Consider how much you can pull from your 401(k) and Roth IRA without incurring penalties.
Here’s another bit of fancy footwork [Kevin McKinley would] suggest considering in your drill, keeping in mind once again that this is an only-if-necessary plan. If you have a working spouse, you could borrow twice as much money from the spouse’s 401(k) as you think you’ll need for living expenses. Pay it back slowly, as you would with the credit card. Then, if at some point your spouse is out of work, too, at least you have the money you need in addition to money left over to pay taxes and penalties you may be assessed if your spouse’s employer demands immediate loan repayment and you can’t comply. Once your spouse lost the job, you probably wouldn’t be able to borrow against the 401(k) anymore.
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For those fortunate enough to have some savings, Mr. McKinley notes that a Roth I.R.A. is a good account to tap, because you can generally withdraw your initial contributions (though not your earnings) before retirement without taxes and penalties. He suggests breaking into college savings accounts, too, if necessary, even if there are taxes and penalties. After all, borrowing to send a child to school is reasonably easy for people with decent credit.
Remember, this isn't day-to-day financial planning, this is planning for emergencies. Working through a financial fire drill and seeing how much the little things adds up might actually convince you to spend less now, which has the bonus benefit of beefing up your savings. More than anything, planning out the worst case scenario gives you a better sense of your financial standing, and should give you the confidence to react to disaster with poise, not panic.
Preparing Your Budget for Disaster [The New York Times]
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Comments:
Sorry, but this is "ant and the grasshopper" stuff. If people have the money and resources but aren't preparing ahead of time for hard times, it's a little late now.
If everybody had been living within their means for the past ten years instead of borrowing to buy things they can't afford, the height wouldn't have been so high and the bottom not so low.
It's almost like the game "Lemmings": if you plan ahead and keep the drop less than a certain height, everyone will survive.
@P_Smith: Some of these tips are useful for people like me, who are literally JUST starting out in their careers. I've been out of university for six months. Ten years ago I was living with my parents and going to high school... I didn' thave any "means" to live within! Today I have a plan in place to pay off my student loans in the next four years, I don't have any other debt, and I've saved about a quarter or a fifth of what I'll need to put a down payment on a nice, two-bedroom condo. However, if I lost my job I would be in major financial trouble. I haven't had enough time in the workforce to save more than I have. I didn't read the whole article but the "Borrow" tip could be especially useful for someone like me. I am in a finacially precarious position not because of The Recession, but rather because I'm a young person just starting out.
@P_Smith: I know so many people that have not been living beyond their means or wasting money on plasma TVs but are still struggling to get their expenses down or to save for emergencies. The cost of everything vs. wages has quietly eroded over the last decade or more.
There are some who foolishly wasted their paychecks, there are plenty who have been trying to just keep up.
Hence (to both of you) why I said those who had the opportunity to save. I know that some people never had the chance to save, I used to be one of them. I've had student loan debt to deal with and my laptop does multiple jobs as stereo, game system and TV and movie screen (with a USB cable adaptor).
Fortunately I've been able to save roughly $800 per month so I will be able to withstand a few punches, but I'd prefer not to tap my savings at all.
I'm working on building my savings, but I suppose I'm a bit lucky. --Since there's no chance of the company I'm working for going out of business anytime soon, if they want to get rid of me, they have to give me 3 months notice. --One nice thing about being in IT in Europe is that skilled employees are generally not considered to be "at will".
This is part of my New Year's resolution - to try and save up something. And hope that our bonuses at work come back. *sigh*
Step 1: Write some obscure novels.
Step 2: PROFIT!
Step 3: Purchase summer, winter, fall, and spring houses. Stock each with plenty of maids and cooks.
Step 4: Banks suck. Invest all of extra fundage into Madoff. He seems OK enough.
Step 5: Lose money.
Step 6: Bitch.
Step 7: MOOOOOOAAAAAAN!
Step 8: Write article mocking everyone with only one "all season" house.
Step 9: Drink virgin blood. (???)
Step 10: PROFIT!
"Emergency plan? I had that extra gallon of blood in my basement this whole time!"
I thought if you borrowed against a 401k and were fired from the job, that you owed the amount borrowed immediately.
@WBrink: Weird, my comment vanished.
Anyway, you can borrow against your 401k and just have to pay yourself back in interest. You can withdraw money from your 401k but have to pay an early disbursement tax penalty. When fired you can leave your 401k or roll it over (there are big tax implications depending on how you do this).
My question is aren't there a couple exceptions from the tax penalty for withdrawing from your 401k like first time home purchase or life changing event?
I'm not particularly fond of the borrowing on credit cards for large expenses thing, that seems counter-productive to me. To be quite frank, I agree with P_Smith on this one. People need to start planning for the future and be more prepared. A good emergency fund will have 3-6 months expenses saved and this sort of exercise won't even be necessary. The kind of advice this type of article should share is how to build up a 3-6 months emergency fund.
Kristy
www.masteryourcard.com
@WBrink:
Yes, loans against a 401(k) must be repaid within some very short time frame (like 30 or 60 days, if I remember correctly) or else it counts as a distribution, subject to taxes and penalties.
This NYT article has so much BS its amazing. Take loans at 40% (i.e. the 401(k) loan), get in even more debt (but rationalize it as "critical repairs"), and reallocate your -retirement- savings (which should have nothing to do with temporary job loss)? This is pretty much a what-not-to-do article.
@P_Smith: What a ridiculous comment. What is "living within your means". If you worked for a company and made 100k per year for 10 years, or worked for $20k per year, when you lose the job you go to zero. Yes everybody could live cheaper. Is your internet service free? Most are not, and is it really necessary. You could not buy a computer and just use the library or not use one at all. You could take the bus, a car is not a necessity. You could live with mom and dad at 45 and reduce rent or house payments. Of course a smart ass could say I paid off my house, which is nice, until you realize you still have to pay property taxes on them.
This is clearly advice if you LOSE your job, and your means change dramatically overnight. A person could work for 10 years, saved 20 per cent of their income, and this advice is valid. Unless you know you can get a job quickly savings can be eaten rapidly.
A 401k loan is not at 40 per cent. You are borrowing your own money and paying yourself back the interest.
Woohoo prostitution here I come!
@thrid001: "Of course a smart ass could say I paid off my house, which is nice, until you realize you still have to pay property taxes on them."
Or that even paid-off houses do things like spring massive basement leaks that provide you an awesome indoor swimming pool, which will run through your emergency fund super-fast when you're working ... let alone when you're not.
We had this happen 18 months ago and it seriously wiped out our entire emergency fund (we'd only been out of school and working for about 1.5 or 2 years at the time, so we'd not been building the fund too long, having bought the house, moved, etc.). We had to start completely over on savings. I have no idea what we would have done if we'd been unemployed or if we hadn't had what little savings we had.
@thrid001: A stupid comment is assuming - as you did - that everyone lives in the same circumstances.
I would be plain screwed. And I've known this for some time. I'm in a debt management program which is good, but also means my accounts are closed for further purchases, so credit it pretty much out of the question.
I have no savings to speak of thanks to said debt program and wouldn't be able to pay rent or my car payment.
I would be moving back in with my mom and probably hitching a ride from her to wor- oh yeah. Never mind.
Well, it looks like the upside to this scenario is that I would get to sleep in and catch up on my day-time television programming.
@SammyD1st: I can't believe the NYTimes would even print an article like this. I can believe the CU owned Consumerist would. Fire Drill? How bout cutting spending, *getting rid* of debt, learning to survive without your Starbucks, Panera lunch, and eating out. Say goodbye to the 300 channel dish and dvr, all you will watch is how the economy sucks. Do stupid things like learn new skills (most of them are free or very low priced), try downsizing your life now so you won't have to live in a "fire drill" mentality. When the job goes away, you will just follow your normal plan. And I know it's beneath some of you to work for less (even though I would bet some are working the fast food shuffle and living in your parent's basement) have the dignity to do any job out there for money, for experience, for yourself. Unbelievable.
It happened to us a week prior to christmas. My husband was laid off with no warning from a national company that did not appear to be in dire straits.
I don't want to name the company as they are still operating as of today, but strange things are happening -when you call corporate, multiple employees are "no longer there" - no explanation...and other strangeness that is pretty wacky. I'm sure they are about to go under.
As far as the suggestions, they seem to be common sense.
We are surviving with my income even with southern california prices, but we have no extras. We are okay. It's becoming cool to be frugal!
Also apply for COBRA to maintain your health care benefits for as long as you can.
@thrid001: True, but having savings greatly reduces the damage. Every dollar you borrow costs you several dollars to pay back. Every dollar from savings costs you $1 to pay back. In addition, the more you tap your credit, the bigger the hit on your credit score.
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Everybody over a subsistence living should save something. If it's $5 a month, then that's better than nothing. Put it away regularly before you have disposable income.
@SammyD1st: Taking money out of your retirement should always be your last ditch effort and come after you've cut every expense to the bone. Sell your TV and furnitiure first.
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If you have to take from your retirement, take from the Roth first. You don't have extra penalties or taxes on the amount you contributed.
I plan on selling my Consumerist commenting account.
Any bidders?