When discussing financial planning with clients, I'm reluctant to use the term "rule of thumb." Bite-size nuggets of information disguised as advice often don't address the complexity of clients' actual circumstances.

Case in point: The idea that an emergency fund should contain at least three months of earned income or at least six months of essential expenses. For baby boomers entering distribution mode, this approach may well miss the mark. Instead of discussing an emergency fund with your clients, perhaps it's time to help them develop an emergency plan - a strategy that takes a more holistic view of their financial situation in the event of an unexpected crisis.

 

A DIFFERENT WORLD

For many years, clients took their employment status for granted. If they were laid off, it would probably be just a matter of a few months before they found something comparable or even better.

But today, with unemployment hovering around 9%, it's a different story. For boomers in particular, getting laid off could be a serious hardship, possibly derailing their retirement plans. In a tough economy, clients need to plan for a lengthy job search and the possibility that a new position could come with a significant drop in pay.

It's also worth reconsidering where clients stash their emergency cash. Checking accounts once yielded decent interest rates. Those days are gone, which means using a bank account may no longer be the best strategy.

What makes an effective emergency plan? Several advisors say they have revamped their approach to emergency planning with baby boomer clients.

 

INCOME STREAMS

There are three main factors to consider when determining the appropriate size for a boomer's emergency plan, says Christine Raines, managing principal of Azimuth Wealth Management in Middletown, R.I. She first determines how many income streams and dependents a household has.

"Typically, more income streams reduce the amount of funds needed, and more dependents increase it," Raines says. In addition, is the client providing for aging parents, adult children or kids with special needs? If so, more funds are probably needed.

She then evaluates how volatile a client's income is: Is it straight salary paid on a regular basis, or is it commissions or bonuses? Consulting fees or sporadic work? Unreliable income increases the recommended level of emergency funds dramatically, according to Raines.

She also looks at whether income streams are correlated. Does a client work in the same field as his or her spouse, making them more vulnerable to economic or industry cycles? "If the client and the spouse have similar threats to their earnings, then we need to boost their savings," she says. "Similarly, if they have a high-risk income stream and it would be hard to match the salary elsewhere, then you must increase the savings."

The lowest reserve that Raines would recommend for a two-income, straight-salary household, where the spouses' jobs aren't correlated, is six months of salary. For a single-income household with dependents and an irregular income stream in a high-risk field, she would recommend 18 months of expenses as an appropriate reserve. If the household falls between those examples, she suggests gauging accordingly and positioning the client somewhere in the middle.

 

MONEY IN, MONEY OUT

Cash flow and budgeting also affect a client's emergency plan. Doug Mavilia, vice president of wealth planning at Lightship Wealth Strategies in Newton Lower Falls, Mass., says there are two key factors to keep in mind. The first is expenses versus salary. It's critical, he says, to ensure that clients who are five to 10 years away from retirement have a handle on all of their expenses.

"Keep in mind that, when they're not working, they'll need to cover expenses, not replace salary," he says. "They won't be paying taxes or setting aside funds for 401(k) contributions, flexible spending accounts, child care or savings."

Mavilia adds that it's important to break out a client's expenses into essentials, such as food, housing payments and utilities, and non-essentials, such as clothes, video rentals and gym memberships. Also, remember that clients may be paying more - perhaps a lot more - to keep their health insurance in force while unemployed.

Clients also need enough accessible cash to pay for their expenses, Mavilia says. "My best advice to clients is to live not only within but significantly below their means, especially within five years of retirement," he says. For example, a two-income household should build a lifestyle off one income and use the other to reduce debt and build savings. If one spouse loses a job, the couple can cut back on savings for that period.

A single-income household should try to keep any required expenses (especially housing costs) low, below 35% of take-home pay, according to Mavilia. This applies to dual-income households as well; the fewer expenses clients have to cover monthly, the easier it is to plan for emergencies and retirement.

In order to develop a proper emergency plan for a client, financial advisors must understand how fiscally conservative that client is, Mavilia adds. Beyond the math and science of calculating the appropriate emergency fund, there is a big emotional component.

"If I recommend that clients keep $60,000 in cash reserves based on their situation, some clients may push back and say they would feel better having $100,000 stashed away for a rainy day," he says. "If that's what it will take for them to feel secure, then it's important to support that decision. I believe it's wise to err on the prudent side, especially with baby boomer clients."

 

FUNDING THE PLAN

Once you decide how much to set aside for boomer clients in an emergency plan, you need to determine where to get that money. "A modern-day emergency fund can come from many different sources," says Robert King, president of the Capital Group in Hyannis, Mass. "Today, we have greater access to our assets, which is important."

In addition to the more conventional sources of funding, such as tapping a savings or investment account, or taking a loan from a 401(k) or life insurance policy, clients have other options. For example, they can withdraw up to 100% of their Roth IRA contributions (but not any earnings) at any time without a tax penalty or a waiting period. Clients can also draw on a home equity line of credit, so it's often a good idea to establish one even if they never plan to use it.

It's also important to review your clients' stock options and other types of deferred compensation. King prefers to inventory all possible benefits and assets a client can borrow from in an emergency.

"It makes sense to use the most liquid assets first," he says. "But the potential debit value of assets that clients may potentially use if they are unemployed for an extended period should also be on the table to discuss."

 

EMOTIONAL SUPPORT

Should your clients have to put their emergency plan into action, they may be prepared financially. However, they must also be prepared to address important emotional issues, says Ed Stiles, founding partner of Retirement Capital Advisors in West Chester, Pa. "Having spent the first half of my career working in the human resources department of a large company, I've seen the strong emotional impact that losing a job or career later in life can have on employees," he recalls.

Stiles first helps clients fully understand their benefit options from the previous employer before he starts crafting any longer-term plans. "Often, I find that employers will be willing to negotiate benefits after a client is laid off, and that's where I can provide value in the process," he explains.

"It's important for the client to do the legwork personally, which allows him or her to emotionally decompress while staying busy with the details associated with collecting benefits," Stiles adds. "It's easy for clients to get depressed if they're not doing anything."

Using all the available information, Stiles runs multiple scenarios and illustrations and starts to have a deeper conversation about benefits and a client's long-term outlook. "We all know that losing a job at 60 is a lot more emotionally draining than at 30," he says. "But keeping the client focused and engaged on a new plan for the future definitely makes a big difference."

A strong emergency plan takes a client's unique financial situation and life circumstances into account. Whereas the rule-of-thumb approach may fall short, a fine-tuned emergency plan should shelter your baby boomer clients - indeed, any of your clients - should the unexpected happen. Helping your clients establish an emergency plan can increase your value as a trusted advisor.

 

Scott Schutte is vice president of financial planning and risk management at Commonwealth Financial Network in Waltham, Mass. He can be reached at sschutte@commonwealth.com. Financial advisors in the article are affiliated with Commonwealth.