There’s one truth I’ve learned from 20 years of personal-finance reporting: People rarely seek advice about their money on a whim. They ask for help because something bad happened. They lost a job. A spouse or child is very ill. They’re getting divorced. Eventually, the emergency passes or becomes a fact of life, and the person swears, “Next time I’m going to be better prepared.”
That’s a line I hear most often from women, who are hit hard by such life crises. A recent survey shows that the loss of a spouse had a very significant financial impact on 46 percent of women but only 17 percent of men. Loss of a job had a very significant impact on 66 percent of women but only 49 percent of men. Trying to manage on the fly just doesn’t work, because when we’re in the middle of it all, we’re too fraught to make the right decisions. “Often a need for urgent financial decisions meets an emotional hurricane,” says Richard Hisey, president of AARP Funds. So what can you do to protect your finances before the worst happens?
You Lose Your Job
Today an average of 55,000 people are laid off every month, and while state unemployment benefits typically last 26 weeks, the average worker is out of a job for a record 35.2 weeks. That’s why I now advocate a larger than usual emergency cushion of nine to 12 months of living expenses, liquid and available in a money market or high-interest savings account. (To find the best savings rates nationwide, go to bankrate.com.)
If you suspect a layoff is coming, explore loan sources. The idea is for you to open a credit line while you’re still employed and able to qualify for a loan. “It’s not that you want to accumulate debt,” says financial planner Jackie Goldstick of Palm Beach Gardens, Florida, “but this will provide liquidity if you need it, in case of an emergency.” One possibility is a home-equity line of credit (HELOC). Most lenders today won’t allow you to borrow more than 80 percent of the value of your home, so to qualify for a home-equity loan or line, you need to have at least 20 percent equity. Some benefits of HELOCs: There may be no closing costs (though there is sometimes a small fee—$50 to $100—for each year the line is open), and you might not pay any interest if you end up not using the money.
Lastly, make sure no more than 10 percent of your assets are tied up in the stock of the business you work for. When a company has mass layoffs, chances are it has fallen on hard times—and you could see your retirement stash vanish right along with your paycheck.
Your Partner Dies
The main way to protect yourself in this case is with adequate life insurance, but how much should you buy? If a couple needs two incomes to pay the mortgage, then both partners should be insured. And if a caregiver would have to be hired for the kids in the event that a stay-at-home spouse died, the life of that stay-at-home spouse should be covered, too. Run the following calculations: First, figure out how much your family needs to live on each year. Then subtract the money you earn yourself. What’s left is how much extra you’d require annually if your spouse were to die. Multiply that amount by the number of years you expect to have the same financial obligations (for example, until you finish paying off your mortgage, or until Social Security kicks in, or maybe forever). The shortfall is what you need to cover with insurance.
Let’s say your annual shortfall is $55,000. One way to ensure you’ll always have that amount coming in each year is to buy an insurance policy that could be either invested or used to buy an annuity that is guaranteed to produce that income. For a $55,000 shortfall, the policy would need to pay out about $1.1 million, according to the bankrate.com calculator, which takes into consideration how long you need the income, how much you require for college and how much you have in savings. To run your own numbers, go to bankrate.com. Click on the insurance tab on the menu, and then, in the links under “insurance calculators” on the left, click on “How much life insurance do I need?”
Remember to re-evaluate your life insurance needs every three years or so. If, say, you bought an extra $250,000 in coverage in case you needed to fund college alone and now your youngest is graduating, you may be able to cut back to a smaller policy. And if your retirement portfolio has grown large enough that it could support you without your spouse’s income, you may not need life insurance at all. Conversely, if the market devastated your retirement stash to the point where it couldn’t sustain you if your partner died, then you’d need to rely on a life insurance policy payout. For couples in this situation, “term” life insurance (the kind many people buy when they’re young because it’s cheap) is no longer the best option, because it ends when the policy expires, at the close of whatever term you established. If you want to re-up at the end of the term, you’ll have to pass a physical—and the older you become, the less likely it is that you’ll pass. Instead, talk to your insurance agent about converting your current term policy to permanent insurance. This will increase your yearly premium, but as long as you pay, it will be active for the rest of your life.
You or Your Spouse Becomes Disabled
Death is the biggest worry on most people’s minds, but statistically it’s more likely that you or your spouse will become disabled. So you need a disability policy or long-term-care plan to make up lost income if you or your partner can’t work. And having such a policy is even more crucial for single people, because there may be no one else to pick up the slack if your income is reduced. Either way, if you’re offered group disability through your employer, buy as much as you can (typically plans are capped at 60 percent of take-home pay). If you can’t get a plan at work, buy coverage from an outside insurer. And even if your employer does provide coverage, it’s a good idea to buy a disability policy from an insurer not associated with your job, to bring your total up to 75 percent of your income. Why? If you want to add coverage later on but you develop a health issue, you may be uninsurable to a new provider; but if you already have an outside insurer, you should be able to buy more coverage without having to take a physical exam.
“It’s important to make sure that your benefit amount keeps up with your income,” says financial planner and physician Carolyn McClanahan of Jacksonville, Florida. “People will buy disability when they’re in their thirties and making, say, $80,000 a year. Ten years later, they’re earning $120,000, and they’ve never increased the amount of disability they have—but they have a new lifestyle.” Disability policies generally stop paying when you hit age 65 or 70. Long-term-care insurance can then help pay for nursing or at-home care. Unless you have a family history of illness at a young age, you can usually wait to buy long-term-care insurance until you’re in your midfifties.
Long-term illness may also mean a diminished capacity for handling important matters. Thus, it’s crucial that you not only keep your estate plan up to date but also sign a living will (to specify whether you want life support) and give someone power of attorney for your health care and finances.
You’re Hit by a Natural Disaster
If it seems as if the incidence of natural disasters has increased, you’re right. The world now averages 400 to 500 a year, according to Oxfam, compared with about 125 a year in the early 1980s. To protect yourself, look at your home-owners’ insurance policy and make sure you have the right “property/casualty” clauses. The key: You should be covered for replacement value, which pays to replace what you lost in a disaster (both the dwelling and the stuff inside, which is typically covered for 50 percent of the value of the house). What you don’t want is cash-value coverage, which pays only the depreciated value of what you lost. Basically, you want enough insurance money to cover the cost of a new flat-screen TV rather than just the cash value of the old model you lost.
Next, if the value of your house has increased since you bought it, make sure you’ve adjusted your homeowners’ coverage to keep up (and if the value has fallen significantly, see whether you need less coverage). In any case, remember you need to insure for the amount required to rebuild and replace what you have. And if you are in an area where you could have a flood, buy flood insurance even if your mortgage lender doesn’t require it. Almost 25 percent of all flood-insurance claims come from areas where the risk was only low to moderate. Says McClanahan: “In Hurricane Katrina, insurers and customers kept arguing over what had damaged the house. Was it flood [covered by flood insurance] or wind [covered by homeowners’]?” In many cases, people who had just one type of insurance were left with no payoff money at all. “If you have both types,” McClanahan says, “someone will pay.”
It’s important to be aware of what your possessions are worth. If their replacement value is significantly more than 50 percent of what your home is worth (which is covered in the replacement-value policy), you’ll need your homeowners’ policy to include contents coverage to make up the difference. If you rent, buy renters’ insurance. To make replacing all your possessions easier, create a photo or video record of what you own and keep it in a safe place outside your home. “A lot of people put this information on their computer, but if that’s in your house, it’s not any good,” Goldstick says. “Instead, keep your photos safe on a website like Shutterfly.”
Take similar precautions with your important documents. Scan copies and keep them in an “online vault,” such as the estate digital lockbox at myestatemanager.com, that offers secure data storage. Or e-mail the scans to yourself if your provider offers free unlimited storage (as Yahoo! and Gmail both do; Gmail has a 25-megabyte limit for attachments). As for the originals? “My family keeps those documents in a plastic bag, and that’s one of the emergency items we take with us when we have to leave the house,” Goldstick says. They are almost as important as food and water.
If a disaster does occur, call your insurer immediately. Take pictures of the damage and create a written record of the destruction. Make two copies of your documentation: one for your adjuster and one for yourself. If you start making temporary repairs on your own, keep all the receipts, then give them to your adjuster so you can be reimbursed.
Originally published in the September 2010 issue of More. Read more of Jean Chatzky's columns here.