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How Building an Emergency Fund Paves the Way for a Secure Retirement

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Just the other day, my pal Bob (well, that’s not his real name, just to be clear) dipped into his IRA to finally take care of some much-needed repairs around his humble abode. The reason he delayed those fixes until the eleventh hour was simple – he didn’t have the cash on hand, at least not in abundance.

Bob has dutifully been stowing away funds in his IRA for quite a while now. However, his unwavering focus on squirreling away money for his golden years left his near-term savings neglected. And, as luck would have it, this neglect came back to haunt him.

A person at a laptop holding their head.

Image source: Getty Images.

Unfortunately for Bob, he’s not reached the age where he can liberally withdraw from a retirement account sans penalties. Consequently, a painful 10% bite was taken out of the sum he withdrew to address his home repairs. But wait, the plot thickens.

The Perils of Plundering a Retirement Stash Prematurely

Penalties, whether for overdue payments or IRS infractions, are never a joyous affair. Likewise, watching 10% of your retirement savings disappear due to an early withdrawal is akin to a financial gut punch.

However, the real catastrophe of prematurely siphoning funds from a retirement account lies in the lost opportunity for investment growth. When you snatch money from an IRA or 401(k), it loses the chance to multiply. And that missed growth might spell trouble down the road.

For instance, imagine pulling out a $10,000 chunk from your IRA or 401(k) at 45 because you’re short on emergency funds. Not only do you kiss $1,000 goodbye upfront, but you also bid adieu to years of potential returns on that $10,000.

If your retirement investments typically yield an average 8% annual return, slightly beneath the stock market’s mean, and you withdraw $10,000 with two decades to retirement, you could be left $46,600 poorer. That’s a far cry from a mere $1,000 penalty.

Establishing Long-Term Financial Stability with an Emergency Fund

By having a cash safety net for those unanticipated expenses, you can dodge the temptation to constantly raid your IRA or 401(k) whenever a monetary crux strikes. This, in turn, allows your nest egg to swell peacefully.

Hence, while saving for the golden years is commendable, the true financial quintessence lies in constructively building an emergency fund. The goal? Stash away enough cash to cover three to six months worth of essential bills.

As for Bob, he’s committed to a change in his saving habits, steering more money towards a conventional savings account. If you’ve been striding down a similar road to savings as Bob, perhaps it’s time for a route adjustment.

Lastly, in case an unexpected expense looms and depleting your retirement coffers seems inevitable, ponder over borrowing against your long-term savings first. While 401(k) loans harbor risk – transforming into withdrawals if unpaid – they’re a safer bet than irrevocably draining your retirement funds.

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The perspectives shared in this article are solely those of the author and may not necessarily mirror those of Nasdaq, Inc.

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