When you get used to the luxury of a steady paycheck, it’s easy to start thinking of it as an endless supply of money. Paychecks are far from endless, though, and it’s smart to have a plan for what to do if they ever stop coming.
The Likelihood of Facing a Loss of Income
Even if your finances are moving along fairly steadily, research shows that you’re probably not as safe from the occasional income disruption as you might think. One study found that by the age of 70, 96 percent of American men had seen a drop of more than 10 percent in their yearly income — not once, not twice, but at least four times over the course of their careers. A quarter of that same group had lived through at least four periods of unemployment, each lasting for a year or longer.
In other words, most of us, whether due to health crises, job losses or other life transitions, are likely to experience a significant income loss at some point in our working lives. And unfortunately, day-to-day expenses like rent, utilities, groceries and car payments don’t stop just because your regular paycheck does. This means that it’s essential to consider both the possibility and the implications of a possible income loss.
How to Handle Income Loss
Don’t wait until you’re struck with a sudden income loss to figure out how to handle it. While you may have friends and family who can help support you through lean times, your safest bet is to plan ahead. Here are four steps you can take now to prepare for and manage the risk of an income loss.
- Build an emergency fund. A liquid savings account with between three and six months’ worth of living expenses is one of your first lines of defense if you experience a loss of income. If you don’t have a savings buffer already, make building one your new priority. Even if your efforts are split between multiple financial goals like paying off debt and investing, having at least some liquid savings is a must to protect against emergencies.
- Live below your means. Letting your tastes get more expensive with every pay raise will leave you little room to build up a financial cushion. Keep your spending low and send that holiday bonus straight to your savings. Watch out for recurring costs that are difficult to reduce — that new job might mean you’re finally able to move into your own apartment, but with a neglected savings account, you’ll struggle to keep up rent payments on a lease you can’t escape if things go south.
- Practice living on a bare-bones budget. When you experience a loss of income, your natural inclination will be to cut back on spending. Sound easy? If you’ve never done it before, it probably won’t be. The more practice you have living with just the necessities, the easier it will be when there’s no choice, and the more financial flexibility you’ll have. Every so often, practice living on a bare-bones budget while you’ve got money coming in. While your favorite delivery app might weep to lose your business for a week, practicing frugality will lay the groundwork for the real thing — plus, it gives you an opportunity to save more aggressively for your emergency fund.
- Avoid being underinsured. While any loss of income can feel like an emergency, income disruptions that are a direct result of accidents or health crises can often be mitigated by having sufficient insurance coverage. Don’t skimp out on health insurance, and consider adding a supplemental insurance policy to your health plan if you find gaps in your coverage. Supplemental plans like critical illness or accident and hospital indemnity insurance can help cover losses of income with cash that gets paid out directly to you, as opposed to your providers. Having access to an immediate cash infusion can help you maintain your financial balance even if an injury or illness prevents you from working for an extended period of time.
It’s easy to take the stability of a steady paycheck for granted, but being prepared for a potential loss of income is one of the best ways for you to maintain financial stability, regardless of the circumstances.