We are often told how important it is to save for retirement, especially as the cost of living for seniors continues to rise and social security is insufficient to support seniors who have no external income. And while it's generally a smart idea to allocate money each month to an IRA or 401 (k), there is a scenario in which you should not actually save for your future: if you do not have the money have to cope with unforeseen expenses in the short term.
You Need Emergency Savings
You never know when a financial emergency could occur, whether in the form of a home repair, vehicle problem or injury. And if you do not have money in the bank to pay for such unplanned expenses, you risk making a lot of debt to cover them. The result? They are wasting money on interest, damaging your balance and making it difficult to borrow money the next time.
If you do not make emergency savings, setting up this safety net should exceed any other financial targets on your radar, including retirement. If you neglect your nest egg, you may indeed lose investment growth, but it is still more important to save money for the present than for the future.
Ideally, your emergency fund should have enough money for a coverage of three included cost of living of six months. If you are single and have no home, you can probably stay at the bottom of that range, but if you have a family and a mortgage, you should focus more on the upper end.
The hard part in building emergency savings is, of course, that you will not get help from the IRS. On the other hand, if you finance a traditional IRA or 401 (k), your contributions will be paid tax-free, saving you money the year you spend them. But there is no tax incentive to bring cash to the bank. However, you must do this because if you ignore your short-term savings, you may be able to incur enough debt that your interest payments alone monopolize your income and force you to neglect your nest egg later.
Well, if you have no emergency savings, but you have some money in an IRA or 401 (k). You may be wondering if you are hired. Can not you just grab the cash because it's yours? The problem is, however, that the IRS does not accept early withdrawals because of the tax relief you receive for financing a traditional IRA or 401 (k). So, if you remove money from an account that is older than 59 1/2 years, you will face a 10% penalty for the payout you receive. And depending on the amount you withdraw, this penalty can be significant.
Let's be clear: As soon as you have a fully loaded emergency fund, you should make a regular contribution to a retirement plan. But if you can not make savings in the short term, this must be your priority – even if it means you have to put aside your nest egg for the time being.