The Importance of Maintaining an Emergency Fund in Retirement

The Importance of Maintaining an Emergency Fund in Retirement

An emergency fund is extremely important for people of all ages, yet it is something that millions of Americans do not have. A 2019 Federal Reserve survey found that nearly 40 percent of Americans would not be able to cover $400 with cash in the event of an emergency. In retirement, an emergency fund becomes extremely important since taking on new debt can cause undue burden, and dipping into a nest egg to cover costs can make it more difficult to stretch retirement savings.

The amount you should save varies individually, so it is important to think about what is appropriate for you prior to retiring and ensuring that you have enough saved. Once the money is saved, you will then need to decide where to keep the money so that it is easily accessible when you need it.

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Why Do You Need an Emergency Fund after Retirement?

The point of creating an emergency fund is to cover unexpected costs without disrupting the usual cash flow or creating new debts to pay for the expense. During your working years, these accounts can cover costs in the event of unemployment. In retirement, the expenses covered by an emergency fund are slightly different. Some of the biggest unexpected costs during retirement include home repairs, car repairs, and health care. These expenses can quickly drain a 401(k) or IRA or swallow up a pension or Social Security payment. An emergency fund in retirement is mostly meant to help handle these sorts of expenses without significantly reducing monthly income, which could make it difficult to cover regular bills.

Taking on new debt during retirement is problematic since retirees are essentially living on a fixed income. With a new debt payment, you may find it difficult to meet the rest of your monthly expenses and end up increasing your disbursements, which in turn increases your risk of running out of money during retirement. Cashing out investments early is also problematic since you may be forced to sell them when you are down, thereby losing money. Having another option for covering unexpected expenses avoids these difficult decisions.

How Much Money Should You Save for an Emergency Fund?

When we’re working, we usually base the amount we should put in an emergency fund on our monthly expenses. Figuring out the right amount in retirement is similar, but you also need to think about the level of caution you want to exercise.

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First, you should look at the amount you spend each month in retirement or the amount that you expect to need to cover your expenses. Typically, monthly expenses include housing costs, food, utilities, transportation, healthcare costs, and sometimes debt payments. You may also want to think about the costs of travel and hobbies, as well as any income that could come from a new side business.

Once you know the amount you need to stay afloat each month, you should think about how large of an emergency fund you want. During the working years, experts recommend saving three to six months’ worth of living expenses. In retirement, it is often wise to expand this number up to 12 months or even as much as 18. Multiplying the number of months by the minimum monthly income needed to cover expenses can give you a rough estimate of how much to save. Additionally, you should aim to save more if you expect to have a lot of home repairs or healthcare expenses.

Where Should You Keep the Emergency Fund?

One of the most important questions you have to answer in relation to a retirement emergency fund is where it should be saved. Emergency funds should be immediately accessible, and ideally, can be taken out without paying fees or tax penalties.

Furthermore, you do not want to put your emergency fund at too much of a risk, so investing it is not always the best option. For those reasons alone, you should avoid putting the money in a traditional IRA, which will require tax payments, or a certificate of deposit, which comes with early withdrawal penalties. A Roth IRA is a possibility since deposits can be made without paying taxes or penalties, but you need to make sure that the investment risk is low.

Often, experts recommend putting emergency funds in a high-yield savings account. These accounts provide higher interest payments than traditional savings accounts, so the money will not stagnate. Plus, the money is safe in a high-yield account.

Also, savings accounts can be linked to a checking account for easy access to the money should an emergency arise. The only issue that you may encounter with such an account is that withdrawals are limited to six per month under Federal Regulation D. Sometimes, retirees will keep part of the emergency fund in a checking account for smaller expenses and then dip into the savings account only when a larger cost arises.