Can You Pass This Key Financial Test?

By Alicia Rose Hudnett Markets Fool.com

It's no secret that Americans are behind in their retirement savings, which should be a top priority for everyone -- but not before they've funded an emergency savings account. Unfortunately, according to a recent survey by GOBankingRates.com, 69% of Americans have less than $1,000 in savings.

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An emergency fund can keep you afloat during hard times. Image source: Getty Images.

What is emergency savings and why everyone needs it

An emergency fund kicks into action when you suffer a major unexpected expense or lose a major income stream (namely, your job). The amount you should save in this account depends on a few factors, like how many earners there are in your household, how stable your job is, and how long it might take to find a job in the current economy. And while many experts recommend an emergency fund consisting of three to six months' worth of expenses, in today's environment of low savings and high debt, I believe more savings is desirable.

Build your financial foundation

Having access to liquid cash is vital. We all need cash that we can access easily, with no strings attached. If you don't already have an emergency fund, start one today, even if you're contributing only small amounts.

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This account should be safe -- think an FDIC-insured cash account withat leastenough money to cover six months' worth of non-discretionary expenses(i.e., bills that you must pay even if you lose your job, like the mortgage). Don't worry about the lack of interest you're earning on this account, as the true value of your emergency fund is its ability to provide cash immediately when you need it.

If you need to accumulate emergency savings but you don't want to put off contributing to your retirement savings, then a Roth IRA can do double duty as an emergency fund and a retirement account. With a Roth IRA, you can always withdraw your original, after-tax contributions without paying taxes or penalties; it's the interest on that principal that has some withdrawal restrictions.

Just be sure to keep some uninvested cash within the account. However you begin your savings account, directing a portion of your money to an emergency fund can be rewarding and empowering.

Don't underestimate the value of cash during your retirement years

You may think that once you're in retirement, you no longer need an emergency fund because you'll have access to your retirement accounts. But that isn't necessarily the case. You'll want to keep some funds handy in a savings account or another liquid alternative like a money market account. If you have to tap your retirement investments during an emergency, then you may be forced to sell during a steep market decline, locking in major losses --and you'll have to pay taxes on those withdrawals if they're made from a traditional IRA or 401(k).

Personal finance is personal responsibility. And life is full of emergencies. Having cash on hand means you're taking responsibility for your financial future, and in the end, that's the most basic form of security.

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