18 October 2008
Consumers strapped for cash and cut off from credit may be looking to less-than-perfect solutions in this less-than-perfect financial environment.
Such steps can be seen as "options of last resort," said Ethan Ewing, president of Bills.com, a San Mateo, Calif.-based personal finance resource Web site.
Sarah Fouquart said she worries that people will turn to these approaches as "short-term fixes." "They scare me if the person doesn't have a longer-term plan to balance their budgets," said Fouquart, regional manager in the Jericho office of GreenPath Debt Solutions, a nonprofit financial counseling organization.
Many financial experts and planners often caution against some of the following approaches. Remembering that everyone's situation is different, here are a few ways those strapped for cash can get some short-term relief, according to experts:
401(k) loan
Many experts say investors should not borrow from their retirement account. However, lacking other options, they say a hardship withdrawal - such as a major medical issue or possible loss of your home - may be your best bet.
At least the overall terms are good, and this is your own money, said Michael Kresh, president of M.D. Kresh Financial Services, an investment advisory firm based in Islandia.
But the real problem occurs, said Kresh, if you leave or get fired from your job. You then have to repay the loan in its entirety within a time frame determined by your circumstances and plan. And if you don't, the money could be taxed at your regular income tax rate and you most likely will be charged a 10 percent penalty, said Andrew Rich, a fee-based financial adviser in Plainview.
401(k) cash-out
Financial planners shudder at this one. If you're under 59 1/2, in most cases you'll be hit with income tax on the money, as well as an early withdrawal fee, said Kresh. And if you're over that age, you still get hit with the tax.
Fouquart said she's had clients who decided this option was "less costly than losing their home or filing bankruptcy," so in some cases there is little choice. But she warns clients who are exploring this as an option that the tax and penalty fees can amount to an estimated 60 percent to 65 percent of their money.
And then, assuming you're close to retirement age, what will you do? In the post-pension era, a 401(k) cannot be seen as a luxury, said Kresh. It's a requirement.
Credit-card cash advance
That deal you just got in the mail looks very appealing.
But "how many people read the fine print on the other side?" Kresh asked.
If they did, they would find the zero-percent interest rate in many cases lasts for a limited time, maybe just three months, and then can jump up to as high as 22 percent to 25 percent.
What's more, those lower, attractive interest rates can skyrocket to the max if you're late with just one payment.
Plus, users can get hit with a flat fee for the transaction, or, perhaps, 3 percent of the amount borrowed.
Cashing out CDs
In most cases with a bank certificate of deposit, you'll be hit with a penalty, which varies based on the amount of the CD and its maturity date.
"If you have four years left on a five-year CD, [the penalty] is different from if you break a six-month CD," said Ray Mignone, a fee-based financial adviser in Little Neck. So ask your bank to give you a breakdown.
If you bought a CD through a broker, it must be sold by the broker, which could result in your taking a loss on the amount you originally invested, said Mignone. The broker may have originally gotten you a CD with a high rate of return, offered by a bank that is now seen as "shaky" and "not too many people will want to buy that CD" now, he said, so you could take a hit.
For these reasons, Rich suggests clients buy "breakable" CDs that allow for, say, a seven-month CD to be broken at the four-month mark with no penalty.
Selling stocks
If you must, you must. But first evaluate options in your portfolio.
Two considerations: how well the stock has done and how long you've held it. If you sell one that has gone up, you'll be hit with capital gains tax. But gains on those you've held long-term - more than a year - will be taxed at 15 percent, as opposed to those you've held less than a year, which will be taxed at your income-tax bracket rate, said Mignone. Also, "selling one with the least amount of gain will generate the least amount of tax."
On the other hand, selling a stock that's gone down will result in an income tax write-off. But, then again, think hard about cashing out a stock that may be down now but is likely to go up, said Rich. His advice is to consider holding those you think have the best appreciation possibilities.
Otherwise, you "lock in the loss. Once you sell it, if it goes up you don't have it anymore," said Mignone.