This Is the No. 1 Reason People Don't Save Enough for Retirement

MarketsMotley Fool

Saving for retirement is never easy. Life happens, priorities change, and before you know it, you're quickly approaching retirement age with little to no money stashed away.

However, if you know where you're most likely to slip up, it can be easier to plan ahead and avoid the most common retirement-planning mistakes.

Continue Reading Below

Among those saving for retirement, 40% of people say that their biggest obstacle is paying for unexpected expenses that pop up, according to a survey from Schwab Retirement Plan Services, making it the No. 1 issue workers face when trying to save for the future. Other common obstacles included paying down credit card debt and being unwilling to cut costs by sacrificing things they love.

No matter how diligent you are in saving for retirement, unexpected costs can derail your plans instantly. All it takes is a broken refrigerator, car troubles, or your kid breaking his arm on the playground to throw your budget out of whack, and all of a sudden, retirement planning gets shoved to the back burner.

While you can't prevent unexpected financial emergencies, there's a simple way to plan ahead to ensure they don't throw off your retirement plans: building an emergency fund.

How an emergency fund can save your finances

Most people probably know that it's important to have an emergency fund, yet the majority of them don't have enough cash in the bank to cover an unexpected expense. In fact, only 39% of people have enough savings to pay for a $1,000 emergency, according to a survey from Bankrate.

What's more worrisome, though, is that many Americans aren't too concerned about their lack of savings. According to a separate Bankrate survey, 62% of participants said they were comfortable with how much they had stashed in an emergency fund -- despite the fact that only 29% of them had enough to cover at least six months' worth of expenses.

In other words, a lot of people don't even realize that they need to be saving more if they want to avoid a potential financial disaster.

A lack of savings is a bigger problem than you may realize, with both short-term and long-term consequences. In the short term, you may need to make financial sacrifices in other areas to cover an unexpected cost, but in the long term, it could potentially cost you thousands of dollars if you put off saving for retirement to pay for these expenses.

For example, say you're 40 years old, you have $50,000 in your retirement fund, you're contributing $250 per month to your 401(k), and don't have any money saved in an emergency fund. When a $3,000 unexpected expense pops up, you shift your priorities so that you're paying $250 per month to cover that cost, while not contributing anything to your retirement fund. At that rate, it will take you a full year to pay that off, at which time you go back to contributing $250 per month to your 401(k).

While one year may not sound like a lot of time in the grand scheme of things, it can set your retirement savings back a step -- which can have serious long-term consequences. If you're earning a 7% annual rate of return on your investments, here's what your total savings would look like if you stopped contributing to your retirement fund for a year compared to if you had been saving consistently:

Age Total Savings When Not Contributing for One Year Total Savings When Contributing Consistently
40 (Today) $50,000 $50,000
41 $53,500 $56,613
45 $83,947 $88,027
55 $208,142 $216,167
65 $452,451 $468,239

Even though the initial expense only cost you $3,000, that one year that you weren't contributing at all to your retirement fund could add up to lost savings of almost $16,000 over a 25-year period.

Also, if your employer matches 401(k) contributions, you could stand to lose even more. In this example, let's say you're earning $60,000 per year and your employer will match 100% of your contributions up to 3% of your salary. That's $1,800 per year, or $150 per month. If you're contributing $250 per month, that would bring your total monthly contributions to $400.

In that case, assuming you're still earning a 7% annual return on your investments, here's how much your savings would be affected if you took a year off of contributing to your retirement fund to pay for a $3,000 emergency expense:

Age Total Savings When Not Contributing for One Year Total Savings When Contributing Consistently
40 (Today) $50,000 $50,000
41 $53,500 $58,480
45 $92,239 $98,767
55 $250,256 $263,097
65 $561,098 $586,359

In this scenario, you could potentially miss out on additional gains of around $25,261 by simply taking one year to pay off a $3,000 expense.

How much should you have saved in an emergency fund?

Now you know how important it is to establish a source of emergency savings. The next step is actually funding it. A good benchmark to aim for is saving enough to cover at least six months' worth of expenses, so in the event of a job loss or other unexpected emergency, you'll be covered for awhile.

To figure out exactly how much money you need to sock away, first create a budget to see how much you're spending each month. Make sure to cover all the essentials here -- mortgage or rent, utilities, car loans, groceries, and any other bills that absolutely need to be paid. You also may choose to add a buffer to account for any expenses that differ slightly each month, such as utilities and groceries. That way, even if you have to spend a little more than you anticipated, you're still covered.

Once you've determined what you spend each month, multiply it by six to see how much you should aim to have saved in total. Then start saving wherever you can. You may need to cut back on some of the not-so-necessary expenses -- such as dining out every week or paying for that expensive gym membership you rarely use -- but even small cuts can go a long way.

It's also a good idea to take advantage of a high-yield savings account for your emergency fund. These accounts will pay you more in interest than the traditional savings account you may have through your bank, which can help your money grow faster.

You can't always avoid unexpected expenses, but you can avoid wrecking your retirement plans when these costs catch you off guard. By establishing a solid emergency fund, you can ensure you're prepared for whatever life throws at you -- as well as build a comfortable nest egg in the process.

The $16,728 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.