Published in: Banks | April 9, 2019
Should Retirement Savings Trump Emergency Savings?
By: Maurie Backman
Your nest egg definitely needs your attention, but should it be your utmost priority?
Image source: Getty Images.
There's a reason we're all told to save money for retirement during our working years: Social Security won't provide enough income to sustain you once you stop collecting a paycheck from your job, so if you don't have a means of supplementing those benefits, you're likely to struggle as a senior. The good news, however, is that if you start setting money aside for retirement at a relatively young age, there's a good chance you'll build enough savings to live comfortably during your golden years.
But what if your emergency fund is pretty much nonexistent? Should you dedicate your limited financial resources to your IRA or 401(k)? Or should you keep putting money into a trusted savings account until your emergency fund is complete?
Your emergency fund needs to come first
No matter how eager you are to start building savings for the future, if you're behind on emergency savings, building that safety net should be your first priority. What does "behind" mean when it comes to emergency funds? Essentially, you should have a minimum of three months' worth of living expenses in the bank, but ideally, more like six months' worth. This way, you'll have cash to access in the event you're slapped with an unplanned bill that your paycheck can't cover. You'll also have money to pay the bills in the event you lose your job and have no income for a few months.
If you don't have anywhere close to three months' worth of living expenses in the bank, then you need to stick every spare dollar you get into savings. If you don't, and you are hit with an unplanned expense, then you'll risk racking up costly debt -- debt that might damage your credit and compromise your financial stability.
Once you have a solid three months of living costs tucked away, you can begin to fund a retirement plan. At the same time, however, it might pay to allocate some of your spare cash toward your emergency fund to get closer to that six-month target.
That said, not everyone needs a full six months of living expenses in the bank. If you don't own a home or a vehicle, don't have kids, and have a stable job in a thriving industry, then you can probably sleep soundly at night with three months of expenses at the ready. And if that's the case, you should feel free to focus on building your retirement savings from that point forward.
Replenishing your emergency fund
You may sit on your emergency funds for years without using them. But what happens when you're forced to withdraw from that fund to cover an unplanned bill? At that point, you may be in the habit of steadily funding an IRA or 401(k). Should you stop socking away those funds for retirement if your near-term savings take a hit?
In an ideal world, you'd be able to replace the money you took out of emergency savings by cutting back on expenses and/or picking up more work, rather than putting the brakes on your retirement plan contributions. But if that's not possible, then you're better off hitting pause on the retirement front and refocusing your efforts on your emergency fund.
It's noble to save for your golden years, and the sooner you start, the more time you'll give your money to grow. At the same time, having a fully loaded emergency fund should trump any other financial goal you set for yourself, and if you're forced to dip into that savings account, replenishing it should become your new top priority. When you need money right away, a robust IRA or 401(k) won't do you an ounce of good if you can't take penalty-free withdrawals from it (which, in most cases, won't happen until you reach age 59 1/2). Therefore you should always strive to make sure your emergency fund is in a healthy place before putting your cash anywhere else.
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