One of the biggest threats to retirement savings isn’t inflation, a stock market downturn, or bad investment choices. That is you.
This is because when the financial crisis hits, many workers will start depleting their retirement accounts to find cash to deal with. It’s no news that 32% of Americans can’t handle an emergency that requires him to have his $400 cash ready. Meanwhile, the average financial crisis cost him $1,400 in 2021, according to LendingClub Corp research.
And for 43% of Americans, retirement is the only emergency savings available, according to Voya Financial, a finance, retirement, investment and insurance company.
As such, establishing and building an emergency fund is one of the most important steps in building a secure retirement.
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If you don’t have an emergency fund, you’ll end up relying on credit cards, payday loans, or retirement savings for emergency expenses. According to Voya, a worker without an emergency fund is 13 times more likely to withdraw from a difficult situation than he is, and is also more likely to reduce his retirement benefits.
Why You Need Emergency Funds
Covering a $5,000 emergency expense with difficult withdrawals from your retirement account creates a lot of problems. First, hardship withdrawals are taxed as income. This means that you must withdraw at least $5,000 to pay taxes on your distribution. In some cases, you may also be subject to an additional early withdrawal penalty of 10%. For example, early withdrawals used to pay health insurance premiums while unemployed are subject to a 10% penalty.
Plus, withdrawals mean your money no longer generates compound interest, reducing the final size of your retirement nest egg.
As a result, as retirement approaches, people without emergency funds will have low account balances and may have to work for many more years before retiring.
Work accounts, such as 401(k) plans, often allow contributors to take out a loan against their account, which helps them avoid taxes and fines, but also reduces their investment balance. Additionally, if the borrower leaves the company, the loan balance is often paid in full. If not repaid, the loan will be treated as a withdrawal and subject to taxes and penalties.
How to build an emergency fund
The key to opening an emergency account is to start with small regular automatic deposits into a dedicated bank savings account. You’ll want to add at least some of the raises, bonuses, or other incidental benefits you receive along the way to gradually increase your contribution rate over time. 1% increase every 1 year or 6 months.
The minimum emergency account goal should be equivalent to three months’ living expenses, but it’s much safer to have six months’ salary or one year’s worth of income set aside. Unlike stocks and other investments, emergency cash should be kept in a savings account with stable balances and easy access in an emergency. This account should be kept separate from the accounts you use for your regular spending and household budgets.
One great opportunity to start or increase your emergency fund is tax season. The average payout this season is $2,903, according to the IRS. This can help provide a good base for emergency funds or add to what you already have in savings.
An emergency fund can help protect your retirement savings by giving you the option of not depleting your retirement savings during a financial crisis. Without emergency funds, workers may be more likely to get out of trouble, take out loans, or reduce their retirement benefits, resulting in less retirement savings.
Tips for financial stability
From building an emergency fund to planning for retirement, a financial advisor can help you on your financial journey. Finding a financial advisor is not difficult. SmartAsset’s free tool matches you with up to 3 vetted financial advisors serving your area and allows you to interview advisor matches for free to determine which advisor is right for you. increase. If you’re ready to find an advisor who can help you reach your financial goals, get started now.
SmartAsset has a variety of free tools to help you stay financially secure. Our Rent and Buy Calculator will help you decide which housing option is more suitable for you. Our Retirement Calculator also provides valuable insight into how much money you need to retire comfortably. For those retiring or nearing retirement, our tax benefits tool will help you assess which states are the most and least tax-friendly for retirees.
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Post No Emergency Fund? Your Retirement Is at Risk was first published on the SmartAsset blog.