We are all told to set aside 3 – 6 months’ worth of expenses in a traditional savings account towards an emergency fund. It’s not a bad idea, but what if that isn’t enough for an uncommon occurrence and you’re in a bind? There are a few alternative options to accessing a larger amount of emergency funds when your emergency fund isn’t enough.
Investment Account
Most investors with a traditional investment account hold mutual funds, stocks and bonds, and will sell them as the need arises. The scenarios whereas you may need a large sum of cash, such as when moving to a new home before selling your old or during a known slow time in your business with the expectation of cash flowing in shortly.
However, there are two problems you may encounter. The first being that your emergency fund isn’t large enough to cover your cash needs, and the other problem is the fact that you will probably owe either ordinary or capital gains taxes on the investments you sell. To get around this, you can designate your traditional brokerage account as a margin account and then borrow up to 50% of the value of the account. There is no waiting for loan approval as with most loans, and you can have the funds transferred into your checking account within a day or less.
The caveat is that you are being charged interest on these funds, but the interest will most likely be much less than paying taxes on the sales of your investments. The absolute worst-case scenario is that your investments plunge after taking a margin loan and then the loan is called. A margin loan should only to be used on a very short-term basis, and not to the maximum, due to the risk of holding investments on margin.
401k Loan
Depending upon the plan you have with your business or at your job, you are generally allowed to borrow a maximum of 50% or $50,000 from your 401k, whichever is less. You must pay the loan back within five years and make payments at least quarterly. The biggest risk to taking out a 401k loan is that it must be paid back in full if you are terminated or the plan is terminated. If the plan is with your own business, then this is not as much of a concern.
IRA Distribution
This can be the riskiest option due to the potential tax impact this can have if not done properly. You are allowed to withdraw funds from your IRA and have 60 days to roll it back into your IRA or another IRA. You are only allowed to do this once during a one year period from the date you made the distribution. If you do not place the funds back, then you will incur both taxes and an early withdraw penalty, which can be steep.
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