A Solid Emergency Fund Could Be Your Ticket to a Strong Retirement Nest Egg. Here's Why

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KEY POINTS

  • If you don't have money on hand for emergency bills, you might have to tap your retirement savings to access the cash you need.
  • Building near-term cash reserves could help you leave your nest egg alone -- and help ensure you don't face a shortfall in retirement.

You may not be able to have one without the other.

You'll often hear that it's important to save money for retirement if you want to live comfortably during your senior years. That could mean contributing to a 401(k) plan sponsored by your employer or putting money into an IRA that you manage independently.

Now, you may be in the habit of steadily funding a retirement savings plan. And if so, give yourself a pat on the back, because that's not an easy thing to commit to.

But if you really want to help ensure you'll be able to kick off retirement with a solid nest egg, you'll need to work on building a strong emergency fund. Here's why.

When you don't want to be forced to tap your nest egg prematurely

It's not all that uncommon to be faced with unplanned bills, whether it's home repairs, car repairs, or medical expenses. The problem, though, is that many Americans aren't equipped to handle a surprise bill.

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A recent SecureSave survey found that 67% of Americans could not cover a $400 expense from money in savings. If you're in a similar boat, it might put your nest egg at risk.

Let's say you don't have any money in your savings account, but you happen to have a $10,000 balance in your 401(k) because you've saved in that plan for many years while taking advantage of matching contributions from your employer. If you're hit with a $3,000 home repair, you may decide to take out a 401(k) loan to cover that expense.

But what if you can't pay that loan back? Not only might you face penalties (because your loan will then be treated as a distribution, and if you're not 59 ½, an early withdrawal penalty will ensue), but you'll also have that much less money in your nest egg.

You might think that retiring with $3,000 less won't really hurt you. But remember, when you remove money from a retirement account, you don't just lose out on principal funds. You also lose out on the chance to grow your money into a larger sum.

So, let's say your 401(k) typically generates an 8% average annual return, which is a bit below the stock market's average, as measured by the S&P 500 index. If you remove that $3,000 when you're 30 years away from retirement, it means potentially missing out on more than $30,000 of future income when you account for lost growth.

Make emergency savings your priority

It's definitely a good thing to save for retirement. But if you don't also make an effort to sock money away for near-term needs and emergencies, you might end up depleting your nest egg over time -- and shorting yourself financially later in life.

At a minimum, you should aim for an emergency fund with enough cash to cover three months of bills. If you can't do that, save enough to cover one month of expenses, and then work your way up from there.

Funding an IRA or 401(k) could leave you in a great spot once retirement rolls around. But make sure to leave yourself with enough emergency savings to let your retirement plan be.

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