One of the keys to successful retirement planning is consistent savings. Setting aside a certain amount of money each pay period or each month helps you build a strong savings habit, and the earlier you begin, the more time your funds have to accrue earnings to supplement your personal contributions.
If you’re already making regular contributions, you might feel like your retirement plan is really humming along. But for some, this is a false sense of security. All it takes is one small thing to bring the entire plan crashing down.
Your retirement plan shouldn’t be your top priority
It may seem to run counter to conventional wisdom, but saving for retirement shouldn’t be anyone’s top financial priority. You’ve got bills to pay, for one, and if you aren’t budgeting money for these first, you’re going to end up with a lot of immediate financial problems.
It isn’t too difficult to budget for your routine expenses such as rent or mortgage payments, because you deal with these every month. Even irregular expenses like car insurance aren’t too hard to plan for once you know the average cost and the frequency of the payment.
But then, there are the unplanned expenses.
You can’t easily budget for an emergency room visit or car accident, because you don’t know when or if they’re going to happen. But you still need some money on hand for these emergencies. Otherwise, when they do occur, you’ll find yourself facing a bunch of new bills that make it impossible to save for retirement or any of your other long-term goals.
It could take years to recover from an ill-timed incident, and by the time you’re ready to start saving for retirement again, you’ll have to come up with a whole new plan. And it’ll likely require you to save even more per month than you are right now to stay on track.
How to emergency-proof your retirement plan
If you don’t want your retirement plan derailed by the unexpected, you need an emergency fund. This is money you have available to help you cover unplanned expenses. A common practice is to have at least three months of living expenses in the fund, though some people prefer to save six or more months’ worth. It’s up to you to decide what you feel comfortable with.
There are a few things you should bear in mind when building your emergency fund. First, keep it in a high-yield savings account or somewhere else easily accessible. You might be tempted to invest the money so you can earn a higher return, but this is risky. You never know when an emergency will arise, and when it does, you have to sell your investments right away, even if that means taking a loss. By keeping your money in a savings account, you won’t have to worry about this risk.
Second, you have to replenish this fund every time you use it, or it won’t be ready for the next emergency. Once you spend some of the money, you need to budget a little bit every month to build it back up again. You should also reevaluate the size of your emergency fund at least once per year. If your expenses are changing, you should increase or decrease the size of your emergency fund accordingly.
And finally, while an emergency fund can help you keep your retirement plan on track through most hurdles, there is one exception: If you lose your job, you won’t be able to contribute to your 401(k) anymore. An IRA might be an option, but you have to limit yourself to the lesser of your annual income for the year or the annual contribution limit. This is $6,000 per year if you’re under 50 or $7,000 if you’re 50 or older.
In this scenario, you might still have to put off retirement savings until you find another job and then set up a new retirement plan. But since you’ll be able to cover your routine expenses with the money in your emergency fund, you hopefully won’t be as far behind as you would’ve been without that backstop.
We can’t control when emergencies will happen or how expensive they’ll be — they’re just a fact of life. If you don’t want them to throw off all of your long-term plans, make sure you have an emergency fund before you work on any of your other financial goals, even retirement.
The $16,728 Social Security bonus most retirees completely overlook
If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more… each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we’re all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.