10 Ways Recession Could Affect Your Retirement Plan (and What to Do About It)

Inflation is running hot, interest rates are rising, and U.S. gross domestic product was negative in the past two quarters. We're not in a recession just yet, but the economic trends don't look great.

Fortunately, the U.S. job market remains healthy. Hopefully that means your paycheck will keep rolling in, for now. That creates a window -- possibly a small one -- to identify your financial weaknesses and put in safeguards to protect your retirement plan.

Get prepared for what may lie ahead with this review of 10 ways a recession can harm your retirement plan. Analyze each relative to your own situation to create your financial action plan.

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A recession, or the threat of one, may encourage you to get defensive and lower your retirement contributions. While this isn't an ideal strategy, it is sometimes necessary. If your emergency fund balance is low, for example, you may need to bolster it quickly -- before you face a potential layoff.

See if you can get creative to keep your contributions as high as possible. You might trim spending in other areas first or pick up a side project for extra income. If you're contributing to a Roth account, you could also shift to higher pretax contributions instead. Pretax contributions cost less because they provide an immediate tax break.

ALSO READ: 3 Great Reasons to Forego 401(k) Contributions This Year

According to the Federal Reserve Bank of New York, household debt ticked up 2% in the second quarter of this year. The increase came from higher mortgage, auto loan, and credit card balances. If the economy deteriorates further as the year progresses, those household debts will likely keep rising.

Higher debt balances generate higher interest expenses -- which can limit your ability to save for retirement. High-rate debt balances can also push out your planned retirement date, since you'd want to repay those accounts before giving up your paycheck.

To minimize those problems, comb through your living expenses and get your budget as lean as possible. The bigger gap you can create between your income and your expenses, the better. Use the excess funds to pad your cash savings account.

Probably the most painful outcome of recession is wide-scale job loss. Losing your job outright cuts off your 401(k) access and wipes out your ability to save. That obviously puts your entire retirement plan on hold temporarily.

To manage this risk, proactively assess the stability of your job. Does your industry typically experience layoffs in economic downturns? If so, what roles are affected most?

If you are in a high-risk group, brainstorm ways to make yourself indispensable. You might take on more responsibility, volunteer to lead committees, or pursue extra training on the side.

Also make a list of second-income opportunities, such as project work or independent consulting. Sketch out how you could pursue those opportunities if you had to.

ALSO READ: Job Seekers Are Rethinking Their Plans Due to Inflation and the Stock Market Decline. Should You?

Recessions often overlap with bear markets. The stock market's already down about 10% over the past 12 months -- additional declines could be ahead if the economy worsens.

If you're invested in stocks, you'll see those declines in your retirement account balance. These setbacks are, unfortunately, unavoidable.

But there is good news: Stock market downturns are temporary. They also benefit you as a purchaser of stocks because your dollar buys more.

If your income remains intact, keep contributing to your retirement account. A recovery will follow, and your continued investments will position you well for future gains.

ALSO READ: How a Bear Market Can Actually Boost Your Retirement Savings

Recessions are one of the reasons you have an emergency fund balance. Lose your income or get hit with higher expenses, and your cash savings is there to bail you out.

Dip into your emergency fund balance if you must. For your retirement plan, spending cash on hand is less damaging than a 401(k) loan or running up your credit card. You can figure out how to replenish your cash savings balance once your situation stabilizes.

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Financial flexibility is your capacity to manage through unexpected financial circumstances. Your liquidity and access to affordable debt largely define how easily you can respond to income loss or higher-than-normal expenses.

In a recession, you might have a harder time borrowing, either because rates are higher or lenders are getting more restrictive. You might also see your home -- your best collateral -- dip in value. That would reduce your ability to access cheap home equity debt.

These circumstances alone shouldn't derail your retirement. But if you also lose your job or you were going to use home equity to help fund your retirement, you'll have to reassess your plan. Brainstorm a backup plan now so you're prepared for the worst-case scenario.

ALSO READ: Here's What a Recession Could Do to the Housing Market

In 2021, financial company Fidelity published a savings factor system to help future retirees track their retirement funding progress. The system recommends saving in multiples of your annual salary, with benchmarks at different ages. By 35, for example, you should have saved double your annual salary. By 55, you'd want to have seven times your annual salary set aside.

If you've laid out similar targets for yourself, an ill-timed recession can easily bump you off course -- either because you pause contributions temporarily or because your account value drops.

Your response in those situations defines how far off-course you end up. For the least amount of long-term damage, stay calm and stick with your plan. Even if you must skip some contributions, get right back to them as soon as possible. Don't worry about the state of the market -- that will resolve itself eventually.

Recessions are most damaging when they sap your portfolio value just before you'd intended to retire. If your nest egg shrinks by 20%, that's not a great time to start taking retirement distributions. Unless you're very well-funded for retirement, you may have to delay your timeline.

Postponing retirement does have advantages. For one, you probably end up with a higher Social Security benefit. You also get to continue retirement contributions. And if the market's down at that time, those contributions will pad your share count efficiently.

Still, if the idea of continuing to work sounds horrible, brainstorm other options. Maybe you could work part-time, or switch to a different full-time role that's more fulfilling.

ALSO READ: Delaying Retirement Due to Stock Market Turbulence? 3 Benefits You Might Reap

When the market's going strong, it's easy to accept risk. But in a recession that's accompanied by a bear market, you may decide you prefer a more conservative approach.

Typically, you'd reset your asset allocation to address a change in your risk tolerance. The thing is, you probably don't want to reallocate your assets in a down market. The liquidations will generate less cash than you'd like.

What you can do is change your investment allocation on new contributions only. That way, you adjust your risk gradually without having to liquidate when share prices are down.

Recessions can raise your living expenses. Inflation is often the culprit, but there can be other circumstances in play. You may have to help a family member who's been laid off, for example. Higher living expenses, in turn, reduce your capacity to save for retirement.

Budgeting is the most reliable solution in this scenario. If you're not using a budget today, start the process now. Go through your expenses and set spending limits. Challenge yourself to live within those limits.

Living on a budget takes practice. But once you get comfortable controlling your spending, you can adapt more quickly to higher living expenses -- hopefully, without having to rob your retirement.

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Recessions can upset your retirement plan in a multitude of ways. Job loss, inflation, and higher debt balances sap your ability to save. If the recession is coupled with a bear market, you'll see the value of your savings drop, too.

Those are troubling, and sometimes unavoidable, circumstances. If you get hit hard by a recession, you'll have to manage through as best you can.

It may help to focus on the future -- because recessions are temporary. You will see the other side, and you will return to your normal cadence of saving and investing. Keep any recession-related detours as short as possible, and your retirement plan should recover.

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