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Emergency fund or retirement savings?

If you are already saving for retirement, do you also need an emergency fund? Find out how each of these accounts can help protect your financial well-being.

4 min read

If you were to have a sudden unexpected bill such as roof repair or medical bill, how would you pay for it? Setting aside money for a specific goal can help cushion you from unexpected bills or big changes in your life such as a job loss. As you work on building your retirement savings, you could also build an emergency fund to cover unexpected expenses when they arise.

When creating a savings goal, you can decide to create an emergency fund and a retirement savings account as separate accounts or a combined account. You can use an emergency fund to set aside funds for unexpected expenses such as car repair and medical bills that often exceed the budget. On the other hand, a retirement savings account can help you build a sufficient nest egg that you can live off in retirement. Unlike an emergency fund, funds saved in a retirement account grow through compounding, and you can accumulate a large nest egg if you start contributing at an early age.

Emergency fund

An emergency fund is a type of savings account that provides sufficient money to cover unexpected bills or major financial changes. It protects you from taking a hit when big unexpected expenses or life changes occur. For example, if you lose your job or experience a drastic reduction in income, you can use the funds saved in an emergency fund before you get another job. Also, the emergency funds can help you meet unexpected expenses such as pet surgery, roof repair, or replacing a faulty HVAC system.

How much should you have in an emergency fund?

The size of an emergency fund may depend on your lifestyle, current income, and monthly expenses. Start by figuring out your typical expenses such as pet care, utility bills, auto care, medical expenses, insurance premiums, and debts you are currently paying. Once you have figured out the monthly cost, you should decide how many months of expenses you should accumulate in the emergency fund. At a minimum, you should have at least three months' worth of expenses in your account, but saving more is better.

For example, if you estimate the monthly expenses to be about $2,000, you should plan to save about $6,000 to $12, 000 for emergency use. If you don't get paid the same amount each week or month, you should try to set aside a specific percentage of your income to your retirement account.

When should you use the emergency fund?

When you set up an emergency fund, you should set guidelines on what constitutes an emergency expense. Not every expense qualifies as an emergency, and withdrawing funds for any expense can quickly deplete the funds. By setting a specific dollar amount for your emergency fund, you can manage the account inflows and outflows so that you have sufficient funds at any given time. Every time you draw from the account, you should plan how to build up the account balance again.

Retirement savings

When you are setting aside funds for unexpected expenses, you should also set aside funds for retirements. Retirement savings are investment options that allow individuals to set aside part of their income for their retirement. The funds set aside for retirement provide a regular source of income after an individual retires. An individual can use different types of retirement accounts such as a 401(k), IRA, Solo 401(k), etc. Retirement savings are used to invest in different portfolios such as stocks, bonds, and mutual funds to generate a return for the investor.

How much should you save for retirement?

When determining how much to save for retirement, you should consider various aspects such as life expectancy, age of retirement, and inflation. If you start saving in your 20’s, you will have more years to contribute to your retirement, and this allows more time for your retirement savings to grow. However, if you start later in life, maybe 40’s or 50’s, you may have to work longer or contribute more money to your retirement account to catch up with a person who started saving in their 20s.

Most experts recommend setting aside 10% to 15% of your pre-tax annual income as retirement savings, including any employer match. High earners target a higher percentage of their income since they have a bigger disposable income to meet their expenses. If your income is not sufficient to set aside 15% every week or month, you should start with a manageable percentage and increase gradually until you reach the target of 15%. Ideally, your retirement income should be about 80% of your final salary. For example, if you currently earn $100,000 annually, you need to have at least $80,000 in retirement income annually to live a comfortable lifestyle.

Emergency fund or retirement savings?

When creating a savings goal, you can create a savings account for each goal you want to achieve. You can create an emergency fund to cushion you from unexpected expenses, and a retirement account to build a nest egg for your future income.

An emergency fund

Setting aside a specific dollar amount in an emergency fund can help you meet unexpected expenses when they arise. An unexpected expense such as car repair or medical bills can hit you hard if you don't have sufficient funds to cover the expense. However, funds held in an emergency fund do not keep pace with inflation, nor earn a return, and therefore, you will be holding money in a money-losing account. Also, some of the risks that an emergency fund covers can be solved at a lower cost using auto insurance, home insurance, health insurance, or even unemployment insurance.

Saving for Retirement

A retirement account such as an IRA provides tax benefits, and it can help you get a tax break on your income. It also allows you to invest the money in a broad range of investment options such as stocks, ETFs, and mutual funds. Funds deposited in a retirement account grow through compounding, including in periods when you did not contribute to the retirement account. If you have an emergency expense such as medical bills, roof repair, or college fees, you can withdraw funds from the IRA to meet the expense.

You don’t have to choose

If you have an old 401(k) left with a former employer, Beagle can help you borrow against the old 401(k) to meet the unexpected expense. Whether you are borrowing to replace your dying car, pay medical expenses for a family member, or to cushion yourself after a job loss, Beagle can help reduce this financial burden. Talk to us to help you unlock your old 401(k)s.