Morningstar - Q4 2020 - 31

signed into law in late March, enables COVID-19affected individuals to take up to $100,000 from
their IRAs and 401(k)s without the additional 10%
penalty that normally applies to early withdrawals.
Taxes on those withdrawals still apply, but the
provision allows them to be paid over a three-year
period and for the funds to be paid back into the
account. Of course, withdrawing from retirement
accounts can be costly. Those withdrawn
funds can't benefit from market appreciation.
Having an emergency fund can also boost peace
of mind and financial confidence in long-term
goals. In a report conducted by AARP, people with
emergency funds felt 2.5 times more confident
in their ability to achieve their financial goals than
those who did not.2
Financial advisors can help clients set a savings
target for their emergency funds based on their
employment status, variability of earnings, number
of earners in the family, and so on.

contributions (not investment earnings) without
taxes and penalty at any time and for any reason.
Assets in health savings accounts can also
be used as an emergency fund-to pay healthcare
costs, obviously, but also to cover nonhealthcare
expenses if the HSA owner had used non-HSA
assets to pay for healthcare costs and can submit
those expenses for reimbursement now.
The fact that so many consumers struggle with
amassing emergency reserves may also
reignite interest among policymakers in allowing
employers to offer so-called sidecar funds. The
idea behind such funds would be for employees
to contribute aftertax dollars automatically
to an emergency fund.3 Automating those
contributions through payroll deductions could
make it easier to save than saving for emergencies
on a purely discretionary basis. Once cash
builds up to the employee's own target, he or she
could direct future pretax contributions to
long-term retirement savings.

Gig economy and contract workers are naturally
at risk for more frequent and longer work
interruptions than permanent workers and,
therefore, should prioritize larger emergency funds
than the standard benchmark. Higher-income
workers and those with more specialized career
paths should target larger emergency funds,
too, because such positions typically take longer
to replace than lower-income, less-specialized
jobs. Dual-income households arguably need
less of an emergency reserve than single-earner
households because the probability of both
earners facing job loss at once is less than the
case for single earners.
Advisors can also help clients determine where to
hold their emergency funds. While a nonretirement
brokerage account is the simplest holding place
for short-term cash needs, other vehicles can
fit the bill. For younger investors, especially, a Roth
IRA can serve as a multitasking vehicle. In a
best-case scenario, the Roth assets would remain
undisturbed until retirement. But in a financial
crunch, the account owner can withdraw his or her

was attributable to reduced healthcare spending.
Declines in healthcare spending were a key
culprit in reduced consumer spending in the
second quarter, too, according to the U.S. Bureau
of Economic Analysis.
Nonetheless, that a health crisis has spurred
higher levels of unemployment points to the
financial challenges posed by a system that ties
healthcare insurance to work.
Financial advisors can help play a role in assessing
options for healthcare in case of job loss or
if the client's employer doesn't offer coverage.
Advisors can also assist clients who have multiple
options for employer-provided coverage in
identifying the best plan for their needs. Nearly
two thirds of workers are employed by a company
that offers both a high-deductible plan and a
traditional health plan such as a preferred provider
organization, according to a 2019 survey from
the Kaiser Family Foundation. Advisors can help
their clients elect the best coverage, taking
into account premiums, healthcare usage and
preferences, out-of-pocket expenditures like
copayments, and the clients' financial wherewithal
to cover unanticipated healthcare outlays, among
other key factors.
Advisors to clients who are covered by highdeductible plans can also help them maximize their
contributions to HSAs. At a minimum, such
accounts can serve as a tax-advantaged way to
cover healthcare expenditures as they're
incurred, as contributions are made on a pretax
basis and qualified withdrawals are also
tax-free ( EXHIB IT 1 ).

Tackling Healthcare Spending
Somewhat counterintuitively, given that COVID-19
is first and foremost a health crisis, spending
on healthcare declined substantially in the
first quarter of 2020. That's because patients and
hospitals deferred in-person nonemergency
medical visits and elective procedures. In fact,
nearly half of the decline in GDP in the first quarter

For clients who can cover out-of-pocket expenses,
the most tax-beneficial way to use an HSA is to
invest it in long-term assets. In contrast with
flexible spending arrangements, where funds must
typically be spent in the same year in which
they're contributed, HSA assets can be invested in
long-term securities like stocks or bonds and can
remain in the account for as long as the investor

2 AARP Public Policy Institute. 2019. "Unlocking the Potential of Emergency Savings Accounts." October.
3 Beshears, J., Choi, J.J., Iwry, M., et al. 2019. "Building Emergency Savings Through Employer-Sponsored Rainy-Day Savings Accounts." Working Paper, November.

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Morningstar - Q4 2020

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