An emergency fund is used to pay 3-9 months of living expenses during unemployment. Keep it for retirement.
Unemployment means that you aren’t paid for doing work. People who either lose their job or retire from work are unemployed. Could you pay for living expenses during unemployment? If not, you should start building an Emergency Fund. There are two important savings plans during life: the Emergency Fund and Retirement Account (ref. 1).
The emergency fund is used to pay living expenses during temporary unemployment and other unusual expenses such as big bills. Workers should save 3-9 months worth of earned income in a secure savings account (ref. 2). That’s a difficult task when also planning to buy expensive items such as cars and houses, or paying-off college loans. Get a headstart in childhood by slowly saving cash in a custodial bank account.
The retirement account is needed to pay living expenses during permanent unemployment in old age. Contribute to your own retirement accounts as soon and often as possible (ref. 3). Begin by opening a Roth IRA during childhood when you start reporting earned income to the Internal Revenue Service (ref. 4). Employer-sponsored and Self-employed retirement plans should be opened at the first opportunity (ref. 5).
About forty to fifty years of regular investing are needed to build adequate savings for retirement (ref. 3). Plan on investing in quality securities such as stock index funds and government bonds (ref 1,6). Begin with stock index funds early in life and add the bonds late in life, finishing with a 90% investment in stock funds and 10% investment in bonds (ref. 7).
Retirement accounts have special rules for investing money (contributions) and removing money (withdrawals).
- Withdrawals before age 59½ years are generally not permitted without paying a fine and taxes [check the rules for exceptions in ref. 5]. There are no fines after age 59½ years.
- Roth IRA. You must pay taxes on all contributions and the contribution limits are $5,500 per year [check ref. 5 for changes]. Withdrawals after age 59½ are not taxed and there are no mandatory withdrawals.
- Other IRAs and retirement plans. The contribution limits vary from $5,500 to $19,000 depending on the account [check ref. 5 for changes]. You don’t pay taxes on any contribution, but withdrawals are always taxed. The government requires partial withdrawals each year after age 70½ years.
1. The Index Card. Why Personal Finance Doesn’t Have to be Complicated. Helaine Olen, Harold Pollack. Penguin Publishing, New York, 2013.
2. Emergency Fund Calculator, MoneyUnder30 . com: https://www.moneyunder30.com/emergency-fund-calculator.
5. Retirement plans: https://www.irs.gov/retirement-plans
6. Saving and Investing for Students, SEC resources for youth: https://www.investor.gov/search/node/students
7. Warren E. Buffett, Chairman of the Board. Letter to the shareholders of Berkshire Hathaway, Inc., 2013. Page 20, 2/28/2014.
Copyright © 2019 Douglas R. Knight