Whether a hurricane, tornado, flood, house fire or other natural disaster, these types of catastrophic events can have devastating and long-term impacts on your financial planning and goals. While nothing can be done to prevent these types of disasters from occurring, pre- and post-planning can help you best weather the storm.
Christine Benz Director of Personal Finance at Morningstar offers advice for those living in areas prone to natural disasters. “To help ensure that you don't raid your retirement assets for non-retirement expenses, it's crucial to have an adequate safety net. That means an emergency fund-true cash reserves, apart from your retirement savings, that you can tap at any time and for any reason without penalty. These reserves should consist, at a minimum, of three to six months' worth of living expenses. Property and casualty insurance is, of course, essential. Be sure to revisit your insurance coverage each year, to make sure that you're adequately insured for the full value of your property, taking any renovations or additions into account.”
Working alongside a financial advisor, you may want to build an adequate emergency fund as part of the normal planning process and obtain all necessary insurance coverages on your home and property. Federal flood insurance can only be purchased via an agent or insurer participating in the National Flood Insurance Program (NFIP).
Benz also suggests taking video inventory of your possessions. “I love the idea of maintaining a video inventory of your belongings-that way you can catalog your possessions and document any upgrades you've made to your property. That should help ease the insurance claims process. I also like the idea of maintaining a digital record of your financial accounts that you periodically back up into the cloud. That's a valuable safeguard in case something happens to your physical documents. Truly difficult-to-replace documents like birth, marriage and death certificates should be stored offsite in a safe-deposit box.”
Steps to take after a natural disaster
Once a disaster strikes, here are some steps you may take:
- Consider taking advantage of any and all government assistance funding that you may be entitled to. FEMA and other agencies generally offer assistance with general living expenses to medical expenses, child care, funeral expenses and others. Check into state and local resources as well to see what aid you might be entitled to.
- You may want to contact your mortgage lender to see if they might offer any type of forbearance or assistance in light of the situation.
- The IRS may offer extra time to make estimated tax payments for those who are self-employed and grant extra time for all taxpayers impacted by a major disaster as they did with Hurricane Katrina.
- Contact your insurer to get the claims process started as soon as possible. If you have flood insurance, you will want to file a claim quickly.
Tapping retirement funds
What if you have financial needs beyond your emergency fund and savings, and what insurance will cover? Your largest pool of money might reside in your 401(k) or other retirement accounts like an IRA.
Tapping these funds may be problematic on several accounts. Withdrawals from retirement accounts are generally taxable. If you are under 59 ½, the withdrawals can be subject to penalties in addition to the taxes due. This becomes an expensive source of funds and may throw your retirement off track.
If you must tap your 401(k), consider a loan if your employer's plan offers this option. There are no taxes due on the loan as long as its repaid according to the terms set forth in the Plan. You can continue to contribute to your retirement while also paying down the loan. The potential danger here, however, is that if you leave this employer for any reason prior to repayment, the loan could become due. If not repaid, the loan might become a taxable distribution.
Benz says, “For people still accumulating assets for retirement, incurring high out-of-pocket costs related to a natural disaster has the potential to reduce the ability to save. In a worst-case scenario, an individual might have to raid his or her retirement account prematurely, resulting in taxes and early-withdrawal penalties.”
“During retirement, it's easy to tap retirement accounts like IRAs without incurring penalties," Benz adds, "but there can certainly be disadvantages to taking large withdrawals to pay for unanticipated, uninsured expenses. On the short list of drawbacks would be that taking too much from a retirement account early in retirement could leave an insufficient amount in place for the later retirement years. In addition, higher-than-anticipated withdrawals from tax-deferred accounts can lead to high tax bills.”
Salvaging your retirement
For those of you who are still working and accumulating assets for retirement, it can be critical to resume/continue adding to your 401(k) and other retirement accounts as soon as possible. While your lives and perhaps your careers may suffer short-term disruption, the biggest single determinant of retirement success is the amount you save and contribute while working.
For those who are already retired or who are on the cusp of retirement, you may face difficult choices. Depending upon your situation, the disaster may cause a minor hiccup in your lives or could lead to larger financial problems. It's important to assess what's been lost, the cost of replacement or moving on and, most importantly, to assess all financial resources available to you.
If you work with a financial advisor, his or her advice can be invaluable. Be sure to discuss any pre-disaster planning at your next meeting, and in the event of a disaster, your advisor can be your go-to source for getting your financial and retirement planning back on track.