Retirement Savings or Emergency Fund: Which Should Come First in 2023?

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There’s a very clear answer. 

You never know when you might end up needing money in a pinch. You might need medical treatment your insurance company won’t cover in full. Or you might need to fix up your car or tackle repairs to your home without any warning.

That’s why it’s crucial to have a fully loaded emergency fund — one with enough money to cover at least three full months of essential living expenses. A Federal Reserve study, however, found that 32% of Americans do not have adequate funds in savings to cover an unplanned $400 expense. As such, it’s fair to assume that many people’s savings could not cover three entire months of bills.

But it’s not just emergencies everyone should be saving for. It’s also important to sock money away for retirement as well. The question is: Which one should take priority for you this year?

Your near-term needs have to come first

Without a decent chunk of money in your IRA account or 401(k), you might struggle to cover your living costs as a retiree. So it’s important to steadily contribute money to one of these accounts year after year.

But if you don’t have a complete emergency fund — meaning, enough money in savings to pay for three months of essential bills — then you should actually hold off on funding your IRA or 401(k) plan until you’ve done some catching up.

The reason? Retirement may be many years away. Meanwhile, an unplanned expense could pop up tomorrow. It’s more important to be able to address that sort of pressing expense than a hypothetical expense in the future.

Also, if you don’t build yourself a complete emergency fund, you’ll risk racking up costly debt the next time you’re faced with an unplanned bill. And if you end up having to waste money on interest upon accruing that debt, you’ll have that much less money to contribute to your IRA or 401(k) plan.

Not having money for emergencies could compromise your ability to save for retirement in other ways, too. If you can’t fix your car due to a lack of funds, you might lose your job. From there, you won’t be able to fund a retirement plan in the absence of a paycheck.

Focus on both if you can

Let’s say you have enough money in savings to pay for three months of bills, but you want a larger emergency fund for added protection. In that case, a good bet could be to split your extra money between your emergency savings and your retirement savings. That way, you’re not neglecting your future self, but you’re also doing what you can to put yourself in a position to better cope with near-term financial surprises.

You should also know that contributing money to a traditional IRA or 401(k) plan will result in a near-term tax break, whereas funding a regular savings account will not. That should also motivate you to spread your money across both types of accounts as long as you have a minimum of three months’ worth of living expenses already tucked away in the bank.

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