If you equate your savings with your retirement account, you may have a one dimensional nest egg. You have money for retirement or some other long term goal, but what about your needs in the meantime? Where will you get the money to meet your short term needs and goals without borrowing from the bank or racking up debt on your credit card?
You could withdraw your retirement money or cash in your savings bonds and annuities early, but it will cost you a substantial penalty in fees, interest and/or taxes. Your retirement account is long term savings that is necessarily difficult to access. Retirement plans (401K and related plans, traditional IRAs and Roth IRAs) which are tax deferred assess penalties if you withdraw money before 59 ½ years of age. Others, such as annuities, certificates of deposit and U.S. Savings Bonds penalize you if you do not hold them long enough
You could borrow against cash value life insurance policies, your 401K (and related plans) and some annuities, but there you go borrowing. You are in debt.
To get out of debt and stay out of debt, you must develop a two dimensional approach to saving: long term savings that are necessarily hard to access coupled with short term, liquid savings that you can get your hands on quickly. This short term money can be thought of as a contingency savings account: money for emergency repairs and replacement of big ticket items (asset replacement), money to tide you over if you should get laid off, choose to change jobs or meet with some financial set back, money for medical emergencies.
Most experts recommend that you have at least the equivalent of three to six month’s take-home pay in your contingency savings account. This is a minimum amount to have available for immediate access. Keep it in a money market account and/or short term (3 to 6 month) certificates of deposit.
Short term contingency savings is your freedom money. It keeps you out of debt. Long term savings is your financial security. You need both to live free of debt. Accumulate them simultaneously, even if you can commit only a few dollars a month to each one.
Don’t raid long term savings for short term needs. You’ll undermine your financial security. Don’t sacrifice saving for the short term to add more dollars to your retirement account. You’ll risk taking on debt and undermine your financial freedom. Maintain a two dimensional approach to saving; you will realize both financial freedom and financial security.
Copyright 2010 K.C. Knouse
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages