Should You Save for Retirement While Unemployed?

Should You Save for Retirement While Unemployed?

The COVID-19 pandemic has caused significant economic disruption. As a result, people may experience pay cuts, find themselves pressured to go into early retirement, or see a reduction in their retirement benefits. Even worse, many people are losing their jobs outright. Unemployment has hit record highs, and millions of Americans are unexpectedly finding themselves out of work. When people lose their jobs, they must confront many difficult financial questions. One question that frequently arises involves saving for retirement. Often, people have worked diligently to put away money, and they do not want to feel like they are backtracking due to unemployment. However, other financial needs often take precedence.

The Importance of An Emergency Fund

emergency

When the question arises of whether it makes sense to continue saving for retirement while unemployed, the most important point to consider is whether or not you can afford to keep putting money away. If you are already having difficulty paying for the essentials, such as housing, utilities, insurance, and food, then you need to focus on those things first. Another important aspect that you should consider before deciding to save for retirement is setting up an emergency fund. In the event that you become unemployed, an emergency fund may actually make it possible for you to continue saving for retirement. Then, when you secure employment again, you can replenish the fund and again focus earnestly on building your retirement savings. Without an emergency fund, you may need to frequently borrow money and pay high interest rates, which you should try to avoid.

During periods of unemployment, most people will focus on keeping their emergency fund going with whatever extra money they have left over after paying their essential bills. Since it could potentially take several months for them to secure employment, replenishing this account in the interim can prove to be a smart move. Some people may find themselves in the situation of having plenty of money in their emergency fund. If you are able to easily make ends meet with unemployment benefits and a substantial emergency fund, then they can consider keeping up with your retirement account contributions. Generally, retirement contributions are less of a priority than an emergency fund and essential living expenses, and they take precedence over things like entertainment and travel. While cutting these fun things from your budget can prove painful, it can help to ensure a balanced retirement fund.

What Methods Can You Use to Save for Retirement While Unemployed?

Once you are in a stable enough position to continue to build your retirement savings while unemployed, you must then tackle the issue of how to save. Many people who find themselves in this position were likely using a company 401(k) plan to save prior to losing their job. Now that they no longer have an employer, these individuals will need to figure out a different solution. Luckily, several other options exist that have similar tax breaks. One of the most common ways to save outside of a 401(k) is an individual retirement account. In 2020, people can make deductible contributions of as much as $6,000 to an IRA or $7,000 if they are at least 50 years of age. The problem is that people need to have earned income from a job or self-employment of at least the amount contributed to deduct, so they need to pay attention to their earnings prior to losing their job and their prospects for regaining employment before the year ends.

The exception to the rule of earned income is the possibility of a spousal IRA. If a spouse has enough excess earned income, he or she can make spousal contributions on behalf of the person who is unemployed. The other issue to consider with an IRA is income limits. For someone who is unemployed, this issue only becomes a problem if a spouse has a workplace plan and combined household income that is greater than $196,000. At that point, the tax breaks for an IRA no longer apply. However, for couples who earn less than this amount, the tax breaks can be quite generous. People may qualify for other tax-advantaged accounts, such as a Roth IRA, depending on their circumstances. If nothing else is feasible, individuals can always open a taxable investment account to fund and revisit balance transfer options down the line.

Takeaways

When people lose their jobs, saving for retirement should no longer be a top priority. First, they need to cover their monthly costs and then focus on maintaining their emergency fund. After these financial issues are figured out, they can then use their leftover cash to fund a retirement account that will enable them to stay on track. Funding a retirement account can help people to avoid getting behind on their savings, which can occur quickly when one accounts for lost compounded interest. For that reason, retirement savings should take precedence over discretionary spending if you become unemployed. When saving, it is important to choose a vehicle that allows for compounded growth and, if possible, tax advantages. While most people will turn to an IRA to make this happen, other options do exist.