An emergency fund is vital regardless of age, but it can be very costly in retirement. By having an emergency fund, you won’t have to use your IRA, 401(k), or other taxable assets for unforeseen expenses. It can also assure that you will not need to seek employment elsewhere.
The key to remaining within your retirement budget is estimating a sufficient amount for your emergency fund. It would be best to determine the appropriate account type for holding the funds.
Why do retirees require a contingency fund?
Emergency reserves are intended to pay unforeseen expenses without liquidating assets or incurring debt. In addition to being a source of backup cash, an emergency fund serves as a savings account during your working years. This might be beneficial if you lose your employment or cannot work for a prolonged period. An emergency fund serves different uses as you approach retirement.
Protecting Investments for the Long Term
If the market is down, withdrawing money from your investment accounts might result in a loss, which is possible during a recession. If you have emergency savings, remove those funds first to allow your portfolio to recover.
Assistance with Medical Costs
When it comes to affording healthcare, emergency savings can bridge the gap. Consider a 65-year-old couple who retires in 2020 without health care from their company. According to Fidelity Investments, this couple may anticipate spending $300,000 on health care, which does not cover long-term care. Accidents, unanticipated diagnoses, or catastrophic illnesses may accumulate medical expenses if insurance or Medicare does not cover the total cost.
Reducing the Impact of Part-Time Job Loss
It doesn’t matter if you have a side hustle, a part-time job, or if your spouse is still employed; an emergency fund can be a source of short-term income if you lose your job.
Coverage of age- or health-related home modifications
If you have mobility challenges, you may need to adjust your house. You may need to construct a ramp, grab bars in the restroom, or widen the corridors and doors. An emergency fund can prevent you from dipping into your pension, 401(k), or IRA.
How Much Should Your Emergency Fund Contain?
Most experts recommend at least three to six months’ living expenses should be covered by emergency funds. The amount you may require in retirement relies on several different variables.
Your monthly salary in retirement: This includes Social Security benefits, pension payments, withdrawals from investments, and annuity income.
How resistant your portfolio is to risk: Remember how your assets are distributed.
What you have accessible in liquid savings may include savings accounts, money market accounts, or certificates of deposit.
By multiplying your estimated monthly costs by the number of months you want to cover, you can estimate the amount of an emergency fund. Suppose you wish to accumulate a 12-month emergency fund and your monthly costs are $5,000. Therefore, you would need $60,000 in an emergency savings account.
What if most of your retirement savings are in cash or safe investments? This indicates that market declines would not affect them. You may not require a significantly larger emergency fund than the suggested three to six months of costs.
If the majority of your retirement money is invested in securities such as stocks and bonds, it may be prudent to establish a sizeable emergency fund. This will prevent you from withdrawing invested cash during a down market.
Where Should Your Emergency Fund Be Kept?
Having money in an emergency savings account means having it available and accessible when you need it. And you do not wish for it to be susceptible to market volatility, liquidity issues, or withdrawal costs. For these reasons, FDIC- or NCUA-insured accounts are advantageous.
High-Interest Deposit Account
High-yield savings accounts provide convenient access to your funds and give above-average interest rates on deposits. These accounts may be connected to a bank account to facilitate quick transactions, and traditional banks, credit unions, and internet banks provide them.
Online banks typically provide better interest rates to depositors than traditional banks. However, you may lose access to branches and ATMs.
Currency Exchange Account
Savings accounts and money market accounts are similar. You earn interest on your funds, which are also easily accessible. The distinction is that certain money market accounts also permit check writing, and some may even let cash withdrawals through ATMs or debit cards.
Typically, you may create a savings account with as little as $1. There may be a minimum opening deposit requirement of hundreds or thousands of dollars for money market accounts.
Individual Retirement Account (IRA)
A Roth IRA can be used to save for retirement, and Additionally, it is a viable option for storing an emergency reserve. As a designated retirement account, you will not be taxed on any earnings, including interest and dividends. In contrast to a standard IRA or 401(k), eligible withdrawals are tax-free. At any moment, contributions can be withdrawn tax and penalty-free.
In addition, required minimum distributions (RMDs) are not applicable throughout the account owner’s lifetime. Therefore, there is no requirement to begin taking RMDs at the conventional age of 72 or 70.5 if you attain that age before January 1, 2020.
A qualified withdrawal is one made after the age of 59.5 years, and the account must have at least five years of history.
You may only contribute to a Roth IRA if you or your spouse continue to work and generate money. In 2021 and 2022, couples aged 50 or older with at least one working spouse can contribute $14,000. This totals $6,000 in payments plus $1,000 in catch-up contributions for each spouse. Five years after opening a Roth account, earnings can be withdrawn tax-free.
If you have a Roth IRA, keep your emergency fund separate from your normal retirement money. Within a Roth, it might be stored in a money market or savings account. Use it solely for emergencies, and avoid investing it in anything that might lose value or be difficult to access.
Where You Should Avoid Storing Your Emergency Fund
Some accounts are not designed to provide simple, penalty-free withdrawals; thus, they are unsuitable for an emergency fund.
Account for Certificates of Deposit (CD).
If you remove funds from a certificate of deposit before its maturity, you will incur a penalty. This might erase the majority or all of your interest earnings. In some instances, it might even eat into your principal. The same holds for annuities that have a surrender term.
Avoid accounts that do not guarantee your cash. Any security, including mutual funds, stocks, and bonds, is inadmissible since they may have liquidity problems.
A conventional IRA
Similarly, a typical IRA might not be the greatest option for emergency funds. This is true if you are younger than 59.5 years old. Regardless of age, you must pay taxes on the full amount of each withdrawal. In the absence of an exemption, such as a total and permanent incapacity, an early withdrawal before age 59.5 will result in a 10% extra penalty.
Prioritize accounts that safeguard your funds, do not impose fees, and are quickly accessible.