How 6 Months of Unemployment Changes Your Retirement Plan

You know that phrase about throwing a monkey wrench into the works? The coronavirus pandemic has now become, in addition to a devastating global disaster, a figurative monkey wrench that's upsetting retirement plans for millions of Americans.

In the two weeks ending April 11, 2020, more than 11 million people filed for unemployment. That's a jaw-dropping number considering a normal two-week period would see less than 1 million filings nationwide. The coronavirus pandemic is the culprit, as nonessential businesses remain shuttered to contain the spread of COVID-19.

Image source: Getty Images.

If you've lost your job, you're likely consumed with the immediate problems of how to pay your rent or mortgage, and whether you can afford groceries. Hopefully, you can get through to your state's unemployment office to file a claim that will generate enough income to cover the basics. Then, you can turn your attention to the future and how this crisis alters your retirement plan.

Here are three reasons you may need to rethink your long-term outlook.

1. Savings momentum will slow

You're not making retirement contributions while you're off work, so that will slow your savings momentum. Depending on your age, the change may be minor, or it may be significant. The table below shows six months of contributions in dollars at different income levels, assuming you were saving 10% of your income and your employer matches contributions up to 3%.

DATA SOURCE: Author calculations.

These figures do not account for any missed earnings in your 401(k). Over a six-month time period in the midst of an economic crisis, those earnings are impossible to predict. The stock market has been more stable in recent weeks, but the economic shockwaves from the coronavirus pandemic are far from over.

If retirement is more than 10 years away, though, you could also estimate longer-term earnings lost if you never caught up on those missed contributions. See the table below for how these missed contributions would have grown over 10, 20, and 30 years, assuming an average annual return of 7%.

DATA SOURCE: Author calculations.

As you can see, the real issue with missing contributions now is the lost earnings over long periods of time.

If you have decades until your projected retirement date, you can't make up for six months of unemployment today by working an extra six months before you retire. That may help you catch up on the contributions themselves, but you'd still be out the earnings. To stay on the same retirement timeline, you'd have to increase your contributions significantly once you get back to work.

2. You're forced into a lean lifestyle

Unemployment normally covers 45% of your working income, on average, and the CARES Act allows for an additional $600 weekly. Some people could get most of their income replaced by unemployment, but many will have to get by on less. If you're forced into a lean lifestyle, you'll have no choice but to eliminate every expense that's not essential.

But here's some food for thought. Social Security on average replaces 40% of your working income. That's a lower percentage than what most people will earn on unemployment, especially without the extra payment from the CARES Act. If the idea of living on unemployment terrifies you, then the prospect of retiring without sufficient savings should be even scarier.

Use that fear as motivation to save. Once you get back to work, you don't have to return to your former lifestyle. You learned to cut out unnecessary spending; why not hold on to a leaner lifestyle going forward? The money you save can go toward your retirement, to protect you from another lifestyle downgrade later.

3. You have time on your hands, like you would in retirement

In this unemployment environment, you may find it difficult to throw yourself into the process of finding a new job. Companies across industries have announced hiring freezes, with some even rescinding job offers that had already been extended. Once you fix up your resume and put out feelers to your network, there might not be much else to do but check job listings daily.

Since you should have the time, reflect on what an ideal retirement looks like for you. Could you see yourself living simply, passing the days with good books and movies? Or, are you going batty at home right now, dreaming of the days when you can take a road trip or join friends on the golf course, followed by a drink at the clubhouse? Do you miss the satisfaction and interaction you were getting from your job?

Based on how you're feeling about being away from work now, you may decide, for example, that the ideal retirement involves part-time work or volunteering, the pursuit of hobbies, plus some travel. With a clear vision in mind, revaluate your savings plan to ensure you're on the right path.

Make a better retirement plan

Yes, a stint of unemployment tosses a monkey wrench right into your retirement plan. It's not all bad, though. You'll need to find a way to catch up on lost contributions and earnings, but you can also use this time to explore what it's really like to downsize and have lots of free time on your hands -- which sounds a lot like a retirement test-drive. You can make the best of a bad situation by taking the opportunity to make a better plan for the future.