One of the main reasons to have an emergency fund during your working years is to provide funds in case of a job loss. Personal finance “rules” usually point to a job loss as being one of the major financial disruptions one can go through. But what about when your job is no longer a concern? Once you retire, the need for an emergency fund does not go away.

Instead, it evolves. Your need for emergency savings and what accounts qualify as emergency savings change.

If you are over 59.5 years old, your retirement plans and accounts most likely no longer have early withdrawal penalties. In some ways, this means your emergency fund has expanded significantly. Still, you should have a segregated portion of your assets that is still considered a separate emergency fund.

What Does an Emergency Mean?

To create an emergency fund in retirement, you must first define what the term “emergency” means to you. Some recommendations call for using a strict definition of “emergency.”

This strict definition would include only things you cannot plan for. When our Bethesda-based Registered Investment Advisory firm does financial planning, we like to include in our definition things you can plan on happening. Examples include:

Health care and medical expenses (including long-term care)
Helping adult children with their financial situation
Market declines
Once-in-a-lifetime vacations with family
Home and auto repairs

This is certainly not a complete list, but the point is all these things (both good and bad) are real possibilities.

Where Will the Money Be Drawn from?

Approaching an emergency fund in retirement means understanding where you will draw money from if you need it. Increased income from withdrawals of certain retirement accounts could lead to increased Medicare surcharges or increased taxes on your Social Security.

This can vary year to year, but a financial advisor should help you take a proactive approach to your tax planning by helping design a withdrawal process given your current financial situation at the time the funds are needed.

Some of your emergency savings should be in cash in your checking and savings account. This is money you may need very quickly and can access in a matter of hours if needed. The rest of your emergency fund can be invested in a risk-appropriate portfolio with a certain amount of liquidity if the need arises to dip into this money.

The percentage of your emergency fund to have in cash versus investments can depend on interest rates, and given the current rate environment, cash is not generating much interest. A financial planner can help you weigh the options available to you and should certainly include a conversation around risk.

Sometimes an emergency fund can even utilize debt. A home equity loan or even a credit card can be used as financial tools to help bridge an expense into another year.

For example, say taxable income is close to putting you into the Medicare surcharge range (also called IRMAA) and you have an unexpected expense in December. Rather than pulling money out of your IRA in the current year, it would probably make sense to pay the expense with a credit card or home equity loan. That way, you can delay withdrawing the funds (and increasing your taxable income) until January of the next year.

How Much Should I Have in My Emergency Fund?

Lifestyle and expenses are an important component in determining this number. We generally like to see our retirees with at least 40% of their investments in a “war chest.”

This 40% can vary based on risk, but typically it consists of bonds and cash. This should serve as a nice buffer to help weather any major market declines. The makeup of this 40% can vary in terms of the type of account it is in.

For retirees over 59.5, we ideally like to see about three months’ worth of living expenses in accessible cash. This is in contrast to the six to 12 months we usually recommend for pre-retirees.

You may wonder, why less?

As mentioned earlier, if you are still working, you are likely not able to access your retirement accounts without penalty. Also, it is likely your retirement accounts consist of far fewer bonds. Your “war chest” inside of your retirement account is less, thus the need to have a larger emergency fund outside your retirement accounts and usually in cash.

Having an emergency fund is important regardless of your stage in life. Retirees can benefit from working with registered investment advisors who can help them determine the order of withdrawals when the need arises.

Discuss your situation with a fee-only financial advisor.

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