How to Find Emergency Money — and Avoid Tax Problems in the Future

As unemployment reaches its highest level since the Great Depression, millions of Americans have been left scrambling to get by. As of early April, almost a third of U.S. adults were unable to afford necessities like rent or food, according to an Urban Institute survey; the crisis is bound to deepen.

For many, financial survival could come down to desperate measures, like dipping into retirement savings or borrowing money from loved ones. While it’s not easy to think long term in emergencies, financial experts say it’s important to plan ahead even when taking drastic steps. “It’s pretty easy for people to overlook tax considerations if they don’t have the financial awareness around them,” says Chad Hamilton, a financial planner at wealth-management firm Brown and Co.

Here are some options to consider when searching for emergency finances, along with important tax rules to know:

Unemployment benefits

More than 33 million Americans have filed for unemployment benefits over the past seven weeks. Those benefits have been expanded by the CARES Act, which also included onetime stimulus payments for millions of taxpayers.

However, unemployment (and severance) benefits are typically considered taxable income. So, says Hamilton, “don’t just assume the income on your unemployment or severance payments are tax-free.” Instead, check with an accountant to avoid surprises come tax season. (The stimulus payments won’t be taxed.)

Retirement accounts and other assets

Personal-finance experts have long considered the proverbial nest egg to be sacrosanct. In part, that’s because early withdrawals from a tax-advantaged retirement account, like a 401(k) plan or an IRA, are heavily penalized. But the CARES Act temporarily waives that penalty for people who claim hard-ship caused by COVID-19. Withdrawals will still be taxed, but people will have three years to replenish their withdrawn funds, and the tax can be paid ratably over three years. Another option: those with a Roth 401(k) can withdraw their contributions “at any time and for any reason without taxes or penalties,” says Christine Benz, director of personal finance at Morningstar. But withdrawing earnings the account has generated may trigger penalties.

Experts still see dipping into retirement accounts as a last resort. Early withdrawals can jeopardize retirement plans, while selling assets ahead of a recovery could mean missing out on future growth. Matthew Kenigsberg, VP of investment and tax solutions at Fidelity, suggests tapping rainy-day funds before retirement accounts. For those facing unexpected medical expenses, drawing from a health savings account (HSA) or a flexible spending account (FSA) can also be an option. Furthermore, people who have assets like stocks or funds in taxable accounts can sell low and deduct any capital loss, a practice known as tax-loss selling.

Family gifts and loans

For those who are able, it’s natural to want to help struggling friends and family. But gift givers need to be tax-smart–gifts must be reported if they total more than $15,000 in a year, for instance. Still, it’s unlikely that gifts will be taxed unless a giver exceeds the lifetime gift-tax exemption of $11.58 million.

Likewise, lenders should carefully document their transactions, including the amount, interest rate and terms of repayment. (While some may balk at the idea of charging interest payments to a loved one, the IRS sees it differently: an interest-free or below-market loan may be subject to taxes and penalties or treated as a gift.) Lenders also have to report any interest they receive as taxable income. But those borrowing money from friends or family generally don’t have to worry about tax implications.

Whether pursuing any of these options or taking a different approach, it’s wise to plan ahead and avoid rash decisions that could cause further pain when it’s time to file taxes next year. People should talk to a financial planner, accountant or other expert about their individual situations too. “It’s important in times like this to consult with a tax adviser to make sure that you’re dotting all your i’s and crossing all your t’s,” says Kenigsberg.