Pros and Cons of Prioritizing Retirement Savings Over an Emergency Fund

LaylaBird / iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

A recent survey conducted by GOBankingRates revealed that 19% of respondents prioritize retirement savings over emergency funds. While saving for your golden years is a worthy and important goal, it’s important to understand the financial implications of prioritizing it over emergency savings.

GOBankingRates found experts to share their insight on why it may be a good — or bad — idea for you and your finances.

Pros of Saving for Retirement Over an Emergency Fund

Here are some of the pros of prioritizing your retirement.

Taking Advantage of Compound Interest

The earlier you save for retirement, the more you’ll be able to take advantage of the power of compounding interest. Compound interest refers to the interest grown by the gains in your portfolio.

For example, say you start investing for retirement at age 25 with an initial deposit of $500 and add a monthly contribution of $100 until age 65. With an average interest rate of 8% and a total contribution of $48,500, you should have $321,730.08 in your savings because of compounding interest. But the less time your investments have to grow, the less of a return you’ll have when it comes to retirement.

“Emergency funds are typically kept in a more liquid account than retirement savings, meaning they won’t earn as much over the long term as your retirement accounts will,” said Scott Lieberman, founder of Touchdown Money. “If you can sock away some money for retirement when you’re young, your future self will thank you, because even if you take a break to save for your emergency fund, your retirement account will still grow over the decades.”

Taking Advantage of Tax Breaks

“Saving for retirement allows for various accounts that help one with taxes, while saving for emergencies doesn’t provide any tax breaks or incentives,” shared Sebastian Jania from Alberta Property Buyers. Some of the tax breaks and incentives of retirement funds include:

• Funding your retirement with pre-tax dollars: IRAs, 401(k)s and 403(b)s are some examples of accounts that offer tax advantages for your retirement savings. By saving for retirement, you lower your taxable income and, in return, pay less to the IRS that year. There are also Roth accounts that allow you to pay taxes when you earn the money and withdraw it tax-free in retirement.
• Health Savings Account (HSA): Another account that allows you to take advantage of your pretax dollars is an HSA, which you can use to pay for doctor appointments, prescriptions and anything else health-related. Initially, this account can only be used for medical expenses, but once you reach 65 years old, you can withdraw from your HSA for other things, as well — this makes it a potential extra retirement fund, if you don’t end up needing the funds for healthcare.
• Saver’s Credit: Another way to stretch your retirement savings further is by claiming the Saver’s Credit on your income taxes. If you meet the requirements, the Saver’s Credit reduces your tax bill by giving you a refund of up to 50% of what you’ve contributed to your retirement accounts.

Cons of Saving for Retirement Over an Emergency Fund

Here are some of the negative aspects of saving for retirement when you don’t have an emergency fund.

You Won’t Have Money for an Emergency

An emergency fund is one of the crucial building blocks of your financial success, as it keeps you from going into debt to cover unexpected expenses. Unforeseen expenses that are emergencies include vet bills, getting laid off from your job and repairs for your house or car.

If you don’t fund your emergency account before saving for retirement, you may find yourself putting those expenses on a credit card or taking out a loan, which can come with high interest rates.

Penalties for Accessing Retirement Accounts

Another con of saving for retirement over an emergency fund is paying penalties if you need to access your cash. To cover those unforeseen expenses, you might have to access your retirement accounts.

Making a withdrawal from a retirement account may seem like a fast and easy way to cover an emergency, but it comes with a price. Most retirement accounts, such as 401(k)s and Simple IRAs, charge you a 10%-20% fee on the cash you wish to withdraw. This cash is also subject to taxes per the IRS if you are younger than 59 ½ years old and the expense doesn’t qualify for a penalty-free withdrawal.

An example of what this could look like is withdrawing an original amount of $3,000 and then paying a 10% fee for early withdrawal and the same amount for taxes. Instead of getting $3,000 like you initially thought, you’d be getting $2,400 instead.

Saving for retirement over an emergency fund is a personal decision based on your unique circumstances. Remember that the best financial plan would be to have both.

GOBankingRates surveyed 1,037 Americans aged 18 and older from across the country between Sept. 5 and Sept. 7, 2023, asking five different questions: (1) How much money do you hope to save in the next year?; (2) What are you saving money for?; (3) How many savings accounts do you have?; (4) What is the primary method you use to save money?; and (5) What is your biggest roadblock/challenge in trying to save money?. GOBankingRates used PureSpectrum’s survey platform to conduct the poll.

Share This Article: