Franklin D. Roosevelt said, "When you come to the end of your rope, tie a knot and hang on." That's the only option for the millions of Americans who are now unemployed due to the coronavirus pandemic. The government has implemented stopgap measures to help, including expanded unemployment benefits and stimulus payments, but these are intended to cover immediate households needs. There's no solution right now for minimizing affects the pandemic will have on Americans' retirement.
A 2019 report from fund manager Vanguard shows the median balance in 401(k)s and other defined contribution plans was $58,035 for savers over the age of 65. Across all ages, one-third of savers had balances below $10,000 and only one-quarter had saved more than $100,000. The data were gathered from 1,900 qualified retirement plans with 5 million total participants. Sadly, it seems many Americans were severely underfunded for retirement well before COVID-19 existed. Now, in the face of rising unemployment and market turbulence, the outlook is even bleaker.
So, what's an unemployed person to do? Is it even possible to save for retirement while on unemployment? It is possible, although, in truth, it might be counterproductive. You don't want to lock money away if that means you'll have to reach for credit cards to pay your bills. Nor do you want to reduce your liquidity by investing, when there's a chance you'll have to sell those investments in the short-term. To minimize your risk of investment losses due to market volatility, the general rule is to avoid the stock market if you need the money within five years. In your case, you might need it within five weeks. That timeline is way too short to hold anything less liquid than cash.
If you are committed to setting money aside even through these tough times, it'll take some careful planning and budgeting. Here's what to do.
Use the temporary boost from unemployment
The CARES Act, enacted in March of this year, adds a $600 weekly supplement to unemployment benefits through July 31, 2020. Depending on where you live, that supplement may double or even triple the income you receive from your state unemployment system. Without the supplement, unemployment generally covers 40% to 45% of your working income. With the supplement, your unemployment might be 100% or more of your working income. That should give you some flexibility to save.
Review your spending and add up the total cost of your non-negotiable household expenses. With respect to debt payments, many financial institutions are offering payment deferrals for cardholders who are affected by COVID-19. Call up your banks and ask about your options. Payment deferrals will keep your monthly expenses low temporarily, which is good for cash flow. You can probably also cut your grocery bill by 10% if you aren't already clipping coupons and shopping from what's on sale.
Compare the total of your essential expenses to your unemployment benefit, both with and without the $600 supplement. You'll probably find that you can manage today, but cash will be tight when that supplement expires.
In that case, you will want to save for retirement in two steps:
- Save everything you can through the end of July in a cash savings account. This way, the money will be on hand if you need it when your unemployment benefit goes down in August.
- Once you find work or your situation stabilizes, review your savings balance. If you can pay down a high-rate credit card to streamline your monthly budget, do so. Then take anything you don't need to keep on hand for emergencies and put it in your retirement fund.
Where to save once you're stable
Once you're sure you won't need the cash to make ends meet, set up an IRA if you don't already have one. A Roth or traditional IRA will work, although the Roth is more flexible with respect to withdrawals. You don't get a tax deduction for putting money into a Roth IRA, but you can withdraw your contributions without taxes or penalties. Your earnings, though, are off-limits until the age of 59 and a half. After that, Roth IRA distributions are tax-free.
Contributions you make to a traditional IRA may be tax-deductible, but there are limitations on your withdrawals. Normally, you pay income tax plus a 10% penalty when you take money out of a traditional IRA. However, in 2020 only, that penalty is waived on withdrawals of up to $100,000. Once you reach retirement age, your traditional IRA distributions are taxed as income.
This year, you can contribute up to $6,000 in your IRAs, or $7,000 if you're over 50. You cannot contribute more than your earned income, however. That means if you only made a total of $5,000 in wages and self-employment income for the year before you went on unemployment, you can't contribute more than $5,000 to your IRAs. Also, you're only eligible to contribute to a Roth IRA if your income is $139,000 or less as a single filer, or $206,000 or less as a married filer.
Create good habits
Saving for retirement while on unemployment is a tricky thing. Locking money straight away in a retirement account isn't the right move. Even so, you can use this time to flex your discipline and build good savings habits. Putting all excess cash into a liquid savings account is the first step. Then, commit to paying off debt or moving some of that savings -- even if it's only $20 -- to your IRA once you replace your income. At that point, you can keep the momentum going by setting up automatic contributions to your IRA or a 401(k) if you have one.
In tough times, it's not so much the amount you save that's important; it's the act of saving under tough circumstances that builds good financial habits. Take control of your finances now and you'll be ready to get moving toward your bigger financial goals once you get back on your feet.