One of the keys to successful retirement planning is substantial savings. Setting aside a certain amount of money each pay period or month helps you develop a strong saving habit, and the earlier you start, the more time your funds have to accumulate income to supplement your personal contributions.
If you are already making regular contributions, you may feel that your retirement plan is making great strides. But for some, it is a false sense of security. All it takes is one little thing to make the whole plan fall apart.
Your retirement plan shouldn’t be your top priority
This may seem to go against popular belief, but saving for retirement shouldn’t be anyone’s financial priority. You have bills to pay, for example, and if you don’t budget for them first, you’re going to end up with a lot of immediate financial problems.
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It’s not too difficult to budget for your day-to-day expenses like rent or mortgage payments because you process them every month. Even irregular expenses like car insurance aren’t too hard to predict once you know the average cost and frequency of payment.
But then there are the unforeseen expenses.
You can’t easily budget for an emergency room visit or a car accident because you don’t know when or if it’s going to happen. But you still need the money for these emergencies. Otherwise, when they do, you’ll find yourself facing a bunch of new bills that will make it impossible to save for retirement or any of your other long-term goals.
It can take years to recover from an untimely incident, and by the time you are ready to start saving for retirement again you will have to come up with a whole new plan. And you’ll probably need to save even more per month than you currently are to stay on track.
How to secure your retirement plan in an emergency
If you don’t want your retirement plan suddenly derailed, you need an emergency fund. This is the money you have available to help cover unforeseen expenses. A common practice is to have at least three months of living expenses in the fund, although some people prefer to save six months or more. It’s up to you to decide what you feel comfortable with.
There are a few things you should keep in mind when building your emergency fund. First, keep it in a high yield savings account or other easily accessible place. You might be tempted to invest the money for a higher return, but it is risky. You never know when an emergency will arise, and when it does, you must sell your investments immediately, even if it means incurring a loss. By keeping your money in a savings account, you won’t have to worry about this risk.
Second, you need to replenish this fund every time you use it, otherwise it will not be ready for the next emergency. Once you’ve spent some of the money, you need to budget a little bit each month to replenish it. You should also reassess the size of your emergency fund at least once a year. If your expenses change, you should increase or decrease the size of your emergency fund accordingly.
And finally, while an emergency fund can help keep your retirement plan on track through most obstacles, there is one exception: if you lose your job, you won’t be able to contribute to your pension. 401 (k) more. A IRA may be an option, but you should limit yourself to the lesser of your annual income for the year or the annual contribution limit. It’s $ 6,000 per year if you are under 50 or $ 7,000 if you are 50 or over.
In this scenario, you may need to defer your retirement savings until you find another job, and then set up a new retirement plan. But since you will be able to cover your daily expenses with the money from your emergency fund, you will hopefully not be as far away as you would have been without this safety net.
We cannot control when emergencies will happen or how much they will cost – they are only a fact of life. If you don’t want them to cancel 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.
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