An emergency fund is something just about everyone can benefit from but surprisingly, the majority of Americans aren’t focused on saving one. Approximately 40 percent of adults couldn’t cover a $400 emergency in cash, according to a Federal Reserve survey.
An emergency fund is important to have at virtually every stage of life, whether you’re a newly minted college grad or you’re heading into retirement in your 50s or 60s. Having emergency savings in retirement is especially useful if you don’t want to tap your nest egg unnecessarily to pay for unexpected costs.
But just how much do you need to have in emergency savings as a retiree? Here’s how to calculate the answer.
Why Emergency Savings Still Matters in Retirement
Generally, an emergency fund is designed to help pay for expenses that come up without warning so that you don’t have to dip into your regular cash flow to cover them or run up debt in the form of a credit card balance or loan. Emergency savings can be especially important during your working years if you lose your job or you can’t work because of a temporary disability and you need money to pay your everyday bills.
In retirement, the need for an emergency fund changes but it doesn’t go away completely.
While you no longer need emergency savings to replace a paycheck from working, you may still need it so you don’t have to drain your 401(k), IRA or Social Security benefits to pay for a major roof repair or a new HVAC system when your old one conks out.
Your emergency savings can also help pay for what’s often the biggest expense in retirement: health care. According to Fidelity, a 65-year-old couple retiring today can expect to spend $280,000 on health care, not including the additional cost of long-term care. An injury related to a fall or an unexpected diagnosis of serious illness could result in medical bills piling up if insurance or Medicare doesn’t cover the full cost. Your emergency savings could help fill the expense gap in those scenarios.
How Much Emergency Savings Should You Have in Retirement?
The answer to this question depends on two things: how much you normally spend each month and how cautious you’d like to be in planning for emergencies.
To drill down to the first number, take a look at your monthly budget. If you’re not yet retired, you can still do this by creating an estimated retirement budget of everything you think you’ll spend. Depending on your anticipated retirement lifestyle, that may include:
- Housing costs, including a first mortgage or second mortgage for a vacation home
- Food and entertainment
- Debt payments if you have credit cards or loans you’re repaying
- Health care expenses and medications not covered by insurance or Medicare
- Insurance premiums for health, life or long-term care insurance
- New hobbies acquired in retirement
- Costs associated with starting a business or side hustle
Compare those expenses to your estimated retirement income, including income you plan to draw from tax-advantaged retirement plans, a pension, Social Security, an annuity or your taxable investment accounts. The goal is to determine the minimum baseline amount you need in income each month to cover your most essential living expenses.
Next, decide how large of an emergency fund you’d like to have. Most experts recommend having three to six months’ worth of emergency savings during your working years. But in retirement, you may want to increase that to 12 or even 18 months if you want to be on the safe side and ensure that you’ll have enough money to cover any curve balls life may throw at you
The final number you need for your emergency savings is simply the baseline amount you need for monthly expenses times the number of months you want to cover. For example, if you want to save a 12-month emergency fund and your monthly expenses in retirement are $5,000, you’d need to have $60,000 earmarked for emergency savings.
Where to Keep Emergency Savings in Retirement
The most important feature of any emergency savings fund is that it needs to be accessible. This is money that you can get to quickly if necessary, without triggering any tax penalties or fees. For that reason, a traditional IRA or a certificate of deposit might not be the best choices for your emergency savings in retirement. You’d owe taxes on traditional IRA withdrawals and CDs can assess penalty fees when you make withdrawals prior to maturity.
You could use a Roth IRA as an emergency fund since qualified withdrawals after age 59 1/2 would be tax and penalty-free. As long as you didn’t need the money, your investments would continue to grow. That could get tricky, however, if you have a large emergency since that could easily wipe out a chunk of your Roth IRA savings, leaving less money for everyday retirement spending or to pass on to your heirs. And if part of your Roth is invested in stocks or mutual funds, that money could lose value if the market experiences a dip.
A better option might be a high-yield savings account. High-yield savings accounts offer better interest rates compared to traditional savings accounts and they’re also safe, both of which you’ll appreciate in retirement.
And you can link your savings account to your checking account for convenient transfers.
Just keep in mind that with savings accounts, you’re limited to six withdrawals per month under federal Regulation D. You may want to keep part of your emergency savings in checking to handle smaller financial blips while leaving the rest in savings to allow it to grow until a larger emergency expense comes along.