Don’t Let a Loss of Income Be a Loss of Hope

July 31, 2013

Every once in a while, we receive a phone call from a person that is in real dire straits when it comes to their financial circumstances. Recently, I experienced just such a call. Frank is a plumber that is temporarily out of work because of injury, and the loss of income was proving to be too much for his household.  The bills were beginning to pile up, and it wouldn’t be long before services would be lost and creditors would start calling.

What’s frustrating about these types of calls is that there is not a lot that can be done after the fact. If the situation is temporary, Frank might be able to work with his creditors to suspend or restructure payments, but if the situation is long term, creditors may not be willing to work with him.  Depending on the circumstances, there may be relief through credit counseling, government programs, or bankruptcy, but often things have to get worse before they can get better, and that’s what Frank is trying to avoid.

It goes without saying that the best way to avoid this situation is not to get into it in the first place, but things happen that are unexpected or beyond our control, and we may end up in a place we never thought we would be.  On that note, the next best thing is to prepare for it.  We hope it never happens, but as my boss likes to say, we should plan for the worst and hope for the best, so here are my suggestions for how we can plan for the worst:

1. Establish and maintain an emergency fund.

Loss of income can be one of the most devastating financial events you face, so the best way to prepare for it is to set aside money, generally 6-8 months of necessary expenses, in an account that can be accessed should a loss of income occur. If you’re just getting started, set up an emergency fund with a local bank or credit union and try to build it up to at least $1,000 within the next 12 months — that’s about $20 a week.  Make it easy by having money automatically deposited through direct deposit or electronic transfer.

2. Maintain adequate disability insurance.

We don’t like to think about it, but the chances of becoming disabled are much greater than the chances of dying before you retire — over 1 in 4 for someone in their 20’s according to the Council for Disability Awareness, citing a U.S. Social Security Administration fact sheet. Most large employers offer disability insurance to employees, but if you work for a small employer or are self employed like Frank, talk to an insurance agent to determine the type and level of coverage that is most appropriate for your situation.

3. Maintain adequate life insurance.

In addition to maintaining adequate disability insurance, it’s also important to maintain life insurance, especially when others depend on you for income.  Several years ago, I shared the story of my neighbor, Mrs. P, whose husband passed away prematurely with no life insurance, leaving Mrs. P with a large mortgage payment and very little income.  Overwhelmed by the expenses, Mrs. P ended up losing her home.

Because people are living longer, life insurance is less expensive today than in the past.  To discover how much life insurance, if any, you need, check out this worksheet.  The Insurance Information Institute also has resources to help you learn more about life insurance.

4. Choose to live on half of your income.

If you are married and both you and your spouse work, choose to live on just one of your two incomes. If only one spouse works, or you are single, try to live off of half the income.  This sounds rather drastic, but it may not be as hard as you think, and there are a myriad of articles that address this idea.  Things like 401(k) contributions, cable TV, cell phones and dining out may take up a good portion of your income already, but when you experience a loss of income, you may have to reduce or eliminate certain expenses like these.

Experiencing a loss of income may require tough decisions, such as deliberately not making a payment, surrendering a vehicle, or in some extreme cases, finding other living arrangements.  No one wants to be forced into making these kinds of decisions, so protect your household by setting aside extra funds, maintaining adequate insurance coverage, and choosing to live well below your means.  It may be too late for Frank, but it doesn’t have to be too late for you.