NEW YORK (MONEY Magazine) - When Beverly Holton began getting notices from the IRS in the late '80s, she had no idea her tax dispute would ultimately lead her to financial disaster.

A single mom, she worked as a computer help desk supervisor at an international company, which listed her as an independent contractor on her W-2 forms. She paid estimated taxes every quarter as required, but the IRS challenged both her status and the amounts she owed. Soon she was being dunned for back taxes and penalties.

Beverly Holton is getting her financial life back on track.

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"I never could seem to catch up," says Holton, now 55 and an executive assistant at a labor federation.

Her financial troubles worsened in 1998, when her mother was diagnosed with Alzheimer's disease. Holton scrambled to provide care and financial support. But the costs of medical care and moving her mom from Virginia to an assisted-living facility closer to her own home in Greenbelt, Md. were more than Holton could afford on her $50,000 salary.

To help meet expenses, she withdrew $15,000 from her 401(k), incurring stiff taxes and penalties. By 2001, with her tax debts exceeding $60,000, she filed for bankruptcy.

Says Holton: "It was the hardest, most depressing decision I ever made."

Holton's story, fortunately, has a happy ending -- or at least a happier second act. Five years after reaching her low point, she's managed to erase her debts and is now able to focus on her key financial goals, which include launching her own business and beefing up her retirement savings.

Sure, Holton still worries that another unexpected emergency could send her right back into a financial tailspin. And in some ways, this is simply a fact of financial life today. In a flexible, highly competitive economy, you are increasingly being asked to shoulder risks once borne by employers or the government.

Unless you're prepared, it is much easier today for events to push you to the brink. Indeed, in a recent survey of workers at 1,000 companies by ComPsych, an employee-assistance company in Chicago, 28 percent said they feel they're "one major setback away from financial disaster."

If you're among the many currently struggling with serious money problems, don't panic. The way out of the morass is, at its core, a matter of simple arithmetic: You need to spend less (maybe seriously less), save more (maybe dramatically more) and be willing to alter your lifestyle to do so. Here are the steps you need to take:

Everyone hits a rough patch once in a while, but the biggest problems occur when you close your eyes to the underlying cause of the crisis.

Ask yourself: Is this a temporary setback from which I'll recover with time (a layoff, perhaps, or an unexpectedly large one-time expense)? Or has there been a more permanent change in my financial status (maybe stemming from a divorce or long-term illness)? The answer will help dictate how you should proceed.

"Often people try to deny the problem and maintain the status quo," says Mari Adam, a financial adviser in Boca Raton, Fla. "But if there's a dramatic change in your life, you need to make dramatic changes in your finances or your problem will get worse."

Your next step: Scrutinize your budget for ways to cut costs and free up cash. If the financial squeeze is temporary, you may come up with the money simply by forgoing a few indulgences -- eating out once a week instead of three times, for example, and giving up premium cable.

But if you face large debts or a major drop in income, you will need to make more drastic spending cuts. Consider selling high-cost assets you can no longer afford -- maybe moving to a less expensive house or giving up a second car.

The more willing you are to make changes now, the faster you will rebuild your assets.

If you're starting to fall behind in your bill payments, contact your credit-card companies and ask them to waive late fees or lower your interest rate by two or three percentage points.

"Most creditors simply want to get paid, so they'll work with you," says Amelia Warren Tyagi, coauthor of "All Your Worth: The Ultimate Lifetime Money Plan."

For those already behind the eight ball, let your creditors know you are in a financial crunch and start negotiating -- ask them to settle for a portion of the debt or give you better repayment terms.

The single best protection against financial disaster is to build a cash cushion that can help you muddle through if unexpected expenses crop up. That's as true when you're working your way out of a crisis as it is on the way in.

"Unless you have extra money available for emergencies, you will be unprepared when more problems occur -- and they always do," says Peg Downey, a financial planner in Silver Spring, Md. "Then you end up charging your groceries and racking up more debt."

So get into the habit of putting a portion of every paycheck in a money-market fund or an account that you can tap quickly if needed.

Start small, at maybe $50 a month, then ratchet up the amount as your finances improve. Aim to keep at least three months' worth of expenses on hand for emergencies.

As focused as you are on resolving your immediate problems, don't lose sight of longer-term goals.

"Think about where you want to be in a year or two, then plot out the steps you need to take to get there," says Adam.

Maybe you want to complete a master's degree that will help you launch a new career, for instance, or to start saving for the down payment on a new house. Whatever you do, don't rob from the future to pay off current debts.

Holton, for example, did not drain her 401(k) to get herself out of trouble (retirement accounts are not part of bankruptcy proceedings). As a result, she's got a leg up on the financial rebuilding process, with a retirement portfolio that's grown in value to $150,000.

Realize too that a setback can lead to unexpected rewards down the road. After a divorce in 1990, Marilyn Capelli Dimitroff had to sell her house in Chicago, give up her brokerage practice and move to Clarkston, Mich., where she took a job setting up a private-banking division.

"It was hard to start over," Dimitroff says. But the job gave her the skills and contacts to open her own financial planning firm five years later. "Now I'm really grateful for what I went through," she says. "Sometimes personal growth can lead to financial growth."

A positive attitude is keeping Holton on track toward her goals too. With her debts paid off, she plans to boost her 401(k) savings and perhaps start her own business. Says Holton: "I'm ready to move on."

As she rebuilds her finances, Beverly Holton is focusing on three major goals: achieving a secure retirement, buying a house and starting her own business. Financial planner Peg Downey of Silver Spring, Md. offers these recommendations:

1. Boost retirement savings. Now that she's paid off her debts, Holton should raise her 401(k) contributions from 5 percent of her salary to 6 percent or more. With the $150,000 she has already saved, this should enable her nest egg to grow to $375,000 in 10 years (at 8 percent gains a year), putting Holton on track to retire at 65 with an annual income of $40,000 (including Social Security).

2. Save for a house. To build a down payment, Holton should revise her budget to free up another $50 to $100 a month, which can be directed into a money-market fund or an online savings account. She should also explore first-time home buyer programs for lower- and middle-income people from federal and local agencies, including Fannie Mae.

3. Start now on a second career. Holton dreams about one day launching her own design business or catering company. Downey urges her to get going now by starting a part-time business that can eventually transition into a full time enterprise. Notes Downey, "Any profits you make from the business along the way can add to your retirement savings."

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