First the car broke down, then the dishwasher stopped working, and now the dog is sick. Sometimes the old proverb, "It never rains but it pours," seems to ring a little too true. When you need money to pay large, unexpected bills, where do you turn? Many people use credit cards or borrow from their retirement savings plan when they have a cash crunch. But those aren't the healthiest choices. One step toward achieving financial wellness is having an emergency fund to use for unanticipated expenses.
Easy Often Equals Expensive
It's easy to use a credit card to pay for a car repair or a trip to the vet. But if you don't pay off the credit card bill right away, interest will be added to your balance. After a few months, you could be carrying a large balance that becomes a financial burden in your life.
Hands Off Plan Money
When you have a large expense, you may be tempted to turn to your retirement plan account balance. After all, it's your money that you've saved. However, borrowing from your plan (assuming the plan permits participant loans) may not be a smart choice. The money you take out of your plan will no longer be invested and benefiting from potential tax-deferred growth. And you will have to pay back the loan. If you aren't able to contribute to the plan while you are repaying the loan, your retirement savings could suffer. If you make a withdrawal instead, it will be subject to ordinary income taxes plus, if you are younger than age 59½, an additional 10% tax for early withdrawal.
Building Your Emergency Fund
Your goal should be to set aside three to six months' worth of expenses in an account that you can access when needed without paying penalties, charges, or termination fees. That amount may seem daunting, but saving even a small amount each month can help you build your fund. Cutting back on your out-of-pocket spending can free up money you can set aside in your fund. And consider putting a portion of any bonus or raise you receive in your emergency fund to help build it up more quickly.
You should use the money in your fund only for financial emergencies, not for things like vacations or non-emergency home renovations. And any time you take money out of your fund, make sure you replenish it as soon as possible so you're prepared for the next unpleasant surprise.
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