Published in: Banks | Nov. 7, 2019
By: Lyle Daly
Is your retirement plan giving you a false sense of security?
For many adults, retirement contributions are automatic. You elect to deduct a certain amount from your paycheck to go towards your 401(k), or you set up a monthly transfer to an individual retirement account (IRA). It's a smart step to ensure that you're building a nest egg for the future.
The problem is that 30% of Americans don't have any money saved outside of their retirement accounts, according to a report by the National Foundation for Credit Counseling (NFCC).
It's tempting to think that when you're saving for retirement every month, you've got your financial situation under control. But there are several reasons why having no other savings can result in serious money troubles.
With emergencies, it's not a matter of "if" but "when." You're going to have the occasional financial problem that you didn't see coming, and that's why every adult needs an emergency fund.
Your car could break down. You or your pet could have a costly medical problem. You may even go through a period where you lose your job and need to get by with little or no income for several months.
If you don't have any money saved, you're gambling that everything will go right and you'll never have any sort of emergency to pay for. That's not a good bet to make, because if you're wrong, you'll either need to go into debt or withdraw from your retirement fund to stay afloat.
In addition to an emergency fund that covers unexpected costs, you also need to save for upcoming expenses that you know you'll have one day. Common examples include:
The point here is that you need to start saving for those expenses now.
If you don't do this, you are putting yourself in a difficult financial situation. You could end up as one of the many consumers who rely on their credit cards for purchases they can't afford. You won't have money put away for big purchases, such as a car or a home, and so you'll either need to postpone these purchases or take on a more expensive loan.
When your retirement fund is your only savings, there's a higher chance that you'll treat it like a piggy bank when you need cash. I've known people who borrowed from their 401(k)s because they figured they'd rather enjoy the money now than wait for their retirement.
There are a lot of problems with this logic, but we'll stick to the most significant ones. Withdrawals from retirement accounts typically carry penalties and taxes, so getting your money out early will cost you. You can borrow from retirement plans in select circumstances, but then you need to pay yourself back.
Most of all, raiding your retirement account cuts into your returns, which is the biggest reason to have one of these accounts in the first place. You can invest your money, in some cases tax-free, and grow it year after year. By getting an early start and investing consistently, you can end up with huge returns in the decades to come.
But if you withdraw or borrow from a retirement account, you're taking a step backwards. It may not seem like an issue now, but it can make a significant difference by the time you're ready to retire.
Making regular contributions to a retirement account is a great habit to get into. That said, it's just one of many habits you need for financial success. You also need to put money away for emergencies and future expenses, because a retirement fund alone isn't enough.
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