3 Ways Being Unemployed Could Hurt Your Retirement

The COVID-19 crisis has driven tens of millions of people into unemployment, and while the near-term repercussions may be obvious, the reality is that being out of work for a lengthy period could prove problematic in terms of retirement, too. Here are three repercussions to keep on your radar.

1. You could wind up with a lower monthly Social Security benefit

Your Social Security benefits are calculated based on your wages during your 35 highest-paid years in the workforce. If you don't work a full 35 years, you'll have a zero factored in for each year you're without an income -- but if you're unemployed for a longer period of time, you might struggle to reach that 35-year-mark. This especially holds true if you've already taken time out of the workforce (say, to raise children, or for another purpose).

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2. Your retirement savings contributions might suffer

If you're out of work right now, you may have to pause your retirement plan contributions until you're back to collecting a steady paycheck. And to be clear, it's imperative that you address your near-term financial needs before focusing on long-term goals (or, to put it another way, it's more important to put food on your table than it is to fund your IRA when you're out of a job and don't have the option to do both). Still, if you normally contribute $300 a month to your retirement savings, and you can't do so for an entire year, you'll be out $3,600 in direct contributions. But when we factor in lost investment growth on that amount, you're actually out more.

3. You may need to tap your retirement savings to get by

The CARES Act, which was passed in March, allows you to take a penalty-free withdrawal from your IRA or 401(k) if you've been financially impacted by the pandemic. That's a good thing, to some degree, because it could help ensure that you're able to pay your bills in the absence of a paycheck. At the same time, any money you withdraw from a retirement plan today is money you won't have available as a senior, and the larger a withdrawal you need to take, the more of a setback it could constitute when you're older.

How to compensate for a period of unemployment

There may not be much you can do to improve your financial picture while you're out of the workforce. But once the pandemic ends, you can take steps to overcome the above challenges.

For one thing, plan to work a bit longer if you're worried your Social Security benefits will otherwise take a hit. Retire at 68 instead of 65 if you can, or even work into your 70s if your health allows for it. Not only will working longer help you boost your monthly benefit, but delaying that benefit past full retirement age will also help it increase for life.

Next, map out a plan to ramp up your retirement plan contributions or put back the money you may have withdrawn. That could mean spending a lot less for a couple of years to boost your savings, and/or getting a second job for a period of time to make your IRA or 401(k) whole again. It might also help to sit down with a financial planner, review the way unemployment may have impacted your retirement plans, and figure out your next steps.

Either way, know this: A period of unemployment could hurt your retirement, but it doesn't have to. You may not manage to recover from that period quickly, and that's OK. The key is to focus your efforts on making smart choices once you're back in the workforce and your paycheck is restored. Do that, and with any luck, those months of joblessness will one day be nothing more than a distant, albeit unpleasant, memory.

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