Having an emergency fund is important in nearly every stage of life, but having one in retirement is essential. Most retirees are no longer earning income and are living off a fixed income from retirement accounts and/or Social Security. Therefore, it could be argued that you should have a loftier savings fund in retirement than while you are working. Emergencies can happen to anyone at any age, but the things that are likely to come up in retirement years are usually more expensive, such as healthcare costs, dental work, and expenses associated with long-term care needs. Many retirees are still living in the home they purchased mid-life. This means their home may require more maintenance and the purchase of bigger ticket items: new roofs, appliances, and heating and cooling systems. There are also modifications for aging in the home to consider, if that is the goal.
It is important to take the time to make a budget in retirement and try to stick with it. Creating a budget will allow you to see what you have coming in and going out on a monthly basis, and what is left over that can be allocated towards an emergency or rainy day fund. Having at least three to six months’ worth of living expenses in a cash account outside of investments is a good place to start. Here are a couple of reasons why having cash is preferred to using a retirement account or taxable investment account as an emergency fund:
- Every dollar that is taken out of a tax-deferred retirement account such as an IRA or 401k is taxed as ordinary income. Using these types of accounts for unexpected expenses creates the potential for increased taxable income with possibly penalties if you have not attained age 59 ½.
- Tapping into investment accounts can deplete the value of the account and its potential earning power in future years. You might also be forced to realize gains in the account, which could cause additional income and tax.
For many retirees, financial security is key to peace of mind. Having an adequate emergency fund provides reassurance that you can weather the unexpected expenses that happen throughout life. As fiduciaries, we always put our clients’ best interest first, which is why we stress the importance of an emergency fund. We want our clients to spend their retirement years doing the things they love and not worrying about how they are going to pay the bills.
If you are interested in learning more about building an emergency fund or any other financial planning topic, please contact Michelle Buxton, Senior Wealth Advisor.
Albion Financial Group