When we think of retirement, most of us envision relaxing days spent doing whatever we want to do. So, it’s important to protect that dream by planning for the unexpected – even in retirement.
Just like your pre-retirement days, unexpected expenses come up; the hot water heater goes, the car needs repairs, you have medical bills, or you want to help your adult children out with their unexpected needs. And, just like your pre-retirement days, it’s important to establish an emergency fund you can easily access and that might keep you from digging into your savings.
How will an emergency fund protect my retirement accounts?
When it comes to investing, I always assume that Murphy’s Law applies.
The time that you need to take additional funds out of your investments won’t be when the market is at an all-time high; it will be when the market has just dropped by ten percent.
This is the worst time to sell as you will have to sell more shares to raise the money and when the market goes back up, you will miss the rebound. It is far better to have set aside the funds in advance for emergencies in a conservative account.
Where should I keep my retirement emergency fund?
- The first thing to remember is that this money should be kept in very conservative funds. This means that the first level of funds should be your savings account at the bank. Once you are over money market limits, the savings account should be transferred to a money market for potentially better interest rates. Choose whichever of the two is highest.
- For the second tier of your cash reserve, I generally recommend CDs. These can be staggered so that you have one coming due every three to six months. Remember, the longer the term on the CD, generally the better the interest rate.
- The third tier of a cash reserve that I recommend is a conservative investment. This has a fighting shot at getting a bit more interest than you are getting in the bank, but still doesn’t take too much risk. You don’t want something that is overly sensitive to what is going on in the stock or bond markets.
How does this emergency account compare to my pre-retirement days?
The rules for an emergency fund are the same whether you are still working or in retirement – three to six months’ worth of your expenses. I always recommend that three is the minimum and six is the maximum.
There is one caveat to be aware of: if you are retired and are using some IRA money as your conservative cash reserve account, consult with your tax advisor before making a distribution to your non-IRA savings account. When you take money out of your traditional IRA, you are generally losing money to taxes. It’s usually better to leave money within the tax shelter of the IRA and defer the taxes as long as possible. It may feel good to see the funds sitting in your bank account, but it won’t feel quite as nice on Tax Day.