We all understand the importance of having an emergency fund. But the reality is that 44 percent of respondents to the Federal Reserve Board's 2017 Report on the Economic Well-Being of U.S. Households reported they could not cover an unexpected $400 expense.1
Unfortunately, without an emergency fund, 29 percent of Americans are dipping into their savings, with 43 percent taking out two or more loans from their retirement plans, according to a recent survey by TIAA-CREF.2 Moreover, 44 percent of those surveyed were said to regret their decision to borrow from their retirement accounts.
The cost of early withdrawalsFor every dollar that's taken from your retirement plan is a dollar less that is earning you compounded interest and reducing what you'll ultimately have saved. But that's not all. Besides the obvious reduction in your retirement plan, early withdrawals from your 401(k) or IRAs can be expensive due to withdrawal penalties and fees. In fact, many tax rules are designed specifically to discourage siphoning retirement accounts. For example, a withdrawal from your IRA or 401(k) before age 59 ½ will typically cost you a 10 percent penalty. So if you're in the 25 percent tax bracket and withdraw $5,000, you'd end up paying $1,750 in taxes and penalties.
Available options for borrowingIf you find yourself in a situation where you need to take out a loan, there are many retirement plans that will waive early withdrawal penalties for life events such as buying your first home, paying for college, to cover specific medical expenses, health insurance costs, or if you become disabled. For more information on retirement plan loans and specific guidelines, visit the IRS website.
Build yourself an emergency fund
Before you borrow from your retirement savings, it's in your best interest to speak with a financial professional or retirement plan representative to discuss the possible long-term impact of taking out such a loan. They can also help you begin to establish and build your emergency fund.
Today, financial advisors typically recommend accumulating an emergency fund of at least six months' worth of living expenses. However, having just a $500 fund is a great start, providing you with some readily available cash to see you through many unexpected expenses. To help get you started in building an emergency money account, try using Bankrate's emergency fund worksheet or Money-Zine's emergency fund calculator.
Too many Americans are looking to their retirement accounts to get out financial binds. Before this happens to you, be sure to weigh all of your options carefully before borrowing or prematurely withdrawing, and consult with a financial professional. Finally, don't delay building your emergency fund. The time to start is today!